chapter 17
Simon likes to watch movies and his Internet service provider offers streaming movies on a pay-per-view basis for $3 each. The provider also offers a service for unlimited streaming of movies for $15 per month. Simon predicts that he will watch three movies per month, so the value of the movies he would watch is not enough to opt for the unlimited streaming option. Therefore, Simon decides to stream movies on a pay-per-view basis. At the end of six months, Simon finds that he only streamed movies an average of two times per month rather than the three times per month he predicted. He is still sure, however, that with the unlimited streaming option, he would watch three movies per month and insists that economic logic supports his prediction. What principle is he thinking about?
Diminishing marginal utility, where less incremental satisfaction is generated from consuming more of any one good.
The sum of the utilities from each possible outcome of a situation weighted by the probability of that outcome is known as ________ .
EXPECTED UTILITY
Consider the following game. You roll a six−sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. Since the expected value of this game is $0, the game is called a(n) ________ .
FAIR BET
As income increases, the marginal utility of an additional dollar increases.
FALSE
If a used-car dealer offers a warranty on the cars he sells, this is a signal that the cars are lemons.
FALSE
Most economists agree that universal health coverage increases adverse selection problems in the market for health insurance.
FALSE
The assumption of diminishing marginal utility of income explains risk-neutral behavior.
FALSE
Why, in the labor market, are contracts often designed to include a variable salary component that is tied to some measure of performance?
Firms use such contracts to differentiate between high and low quality workers.
An example of mechanism design is
HEALTH INSURANCE WITH CO-PAY
Mona Stangley owns an organic egg farm just outside of Gilbert, Texas. At present, she pays her workers an hourly wage to inspect and package her organic eggs in egg cartons. She is considering changing to a piece rate, in which workers would be paid based on how many eggs they inspect and package during a day. Assume on any given day that there are more eggs than the work staff can handle. What effect would you expect this change in compensation to have on Mona's operations?
INCREASE PRODUCTIVITY BC IT GIVES WORKERS THE INCENTIVE TO WORK HARD
For most people, as their income increases, their utility from that income ________ at a(n) ________ rate.
INCREASING/ DECREASING
Explain how imperfect information problems such as adverse selection and moral hazard might affect the following markets. The market for wireless Internet connectivity at large international airports.
It is difficult to know how well a company's Wi-Fi will work until after it is set up due to imperfect information.
A problem that arises when one party to a contract changes behavior in response to that contract and thus passes the cost of its behavior on to the other party to the contract is known as
MORAL HAZARD
A situation where one party to a contract passes on the cost of its behavior on to the other party to the contract is
MORAL HAZARD
Consider the following game. You roll a six−sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. The $30 when you "win" and the −$6 when you "lose" are called ________ .
PAYOFFS
A person willing to play games with negative expected values is considered
RISK LOVING
The market for used automobile tires.
Sellers have more information than consumers, resulting in a disproportionate number of low-quality tires being sold due to adverse selection.
In the labor market, contracts are often designed to include a variable salary component that is tied to some measure of performance.
Such contracts provide workers with the incentive to work hard.
A fair game has an expected value of zero.
TRUE
For extracurricular activities to remain useful as a good signal in the college admissions process, they must be more easily done by well-rounded and productive students than by other students.
TRUE
In situations involving adverse selection, high-quality goods are often squeezed out of transactions.
TRUE
In uncertain situations, consumers make choices to maximize their expected utility.
TRUE
Unlike the problem of adverse selection, labor market incentives such as performance compensation create beneficial selection dynamics.
TRUE
Valentino wants to purchase a classic motorcycle and sees a 1974 Triumph Bonneville T140 listed on Cycletrader.com for $6,000. He is willing to pay $8,500 if the motorcycle is reliable, but only $3,500 if the motorcycle is not reliable. What additional information might Valentino find helpful in making his decision about the purchase?
The reason the seller wants to sell the motorcycle and a reliable opinion on the mechanical quality of the motorcycle.
The market for renter's insurance.
Those with insurance are less likely to take precautions to safeguard their property due to moral hazard.
The five busiest airports in the United States are in Atlanta, Chicago, Los Angeles, Dallas-Ft. Worth, and Denver. At these airports there are more than 450 food outlets, with each airport offering a number of dining options that feature regional cuisines. Passengers will also see many familiar names like McDonald's, Starbucks, Jamba Juice, Burger King, Subway, and Chili's.
Travelers have more information about the quality of these restaurants.
Which of the following is an example of mechanism design?
Welfare reform that limits the amount of time a person can collect benefits.
In addition to market signaling, can signals be used in social settings? In a new place, what signals do you look for to find people who share your interests? Which of the following is true regarding signals in social settings?
Where people go in their spare time signals their interests.
Consider the following game. You roll a six−sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. What is the expected value of the game?
ZERO
Video poker is a very popular form of gambling in casinos, second only to slot machines. Some video poker games offer a "double-up" feature, where players receiving a paying hand are offered the chance to double their winnings. If a player chooses to play the double-up feature, the machine deals one card from a 52-card deck to the player and one to the "dealer." If the player's card is higher than the dealer's (with an ace being the highest card), the player doubles his winnings. If the player's card is lower than the dealer's card, the player loses his winnings. If both are dealt cards of the same value (a push), the player keeps his original bet. Explain if the double-up feature is an example of a fair game. This is an example of
a fair game since the player faces the same probability of winning as he does losing.
A lender faces a(n) ________ problem if borrowers with a greater chance of defaulting on their loans get loans from the lender.
adverse selection
Universal health coverage, lemon laws, and dealer warranties are all examples of tools used to reduce ________ .
adverse selection
A health insurance company charges a level premium to everyone, but determines it is insuring far more unhealthy persons than healthy persons. Therefore, it is forced to raise premiums. The result is that fewer healthy people and more unhealthy people will have insurance. This is an example of the
adverse selection problem
In a market where the buyer or seller enters into an exchange with another party who has more information, there is said to be
asymmetric information
If a buyer or seller enters into an exchange with another party who has more information, there is
asymmetric information and adverse selection.
As a result of adverse selection problems in the health insurance market, it is likely that over time
fewer healthy people will be insured.
Most casino game dealers in Las Vegas are paid minimum wage, and therefore rely on tips for a large portion of their income. Within the past few years, a majority of Las Vegas casinos have instituted tip-pooling policies for their dealers, whereby dealers are not allowed to keep the tips they earn, but instead must pool all tips together to be evenly distributed to all dealers. The tip-pooling system can be expected to
have an adverse effect on the productivity of the most popular dealers.
Find a product advertisement in a magazine for which the missing information tells you something important about the product. From such examples with missing information, we can determine that
lack of important information is a signal that unmentioned attractive features do not exist.
An area of economics that explores how contract or transaction structures can overcome asymmetric information problems is
mechanism design.
A lender faces a(n) ________ problem when the lender lends funds to a borrower for a specific purpose and the borrower then opportunistically uses the funds for another purpose.
moral hazard
If companies that issue health insurance are allowed to inquire about family medical history and the results of genetic testing before deciding to issue insurance policies, it will
reduce adverse selection for insurance companies and benefit those consumers who do not display any family medical problems.
One way insurance companies reduce adverse selection problems is by offering group medical coverage to large firms, and requiring all employees to participate in the coverage. This reduces adverse selection because
the larger the group, the more likely it will include healthy and unhealthy people.
You are in the market for a used 2006 Honda Accord. You know that half of the 2006 Accords are lemons and half are peaches. If you could be assured that the Accord you were buying were a peach, you would be willing to pay up to $10,000. On the other hand, you would only be willing to pay $2,000 for a lemon. You have no ability to discern whether any particular Accord is a lemon or a peach. Sellers of Accords, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $1,500 or more and peach sellers will be willing to sell their cars for $8,500 or more. You are willing to offer ________ for a car of unknown quality and ________ are willing to sell you their car.
$6,000; lemon owners only
At the beginning of 2015 I bought a fire insurance policy for my vacation home in Aspen; at the end of the year, my vacation home had not burned down. Was my purchase a mistake?
No, because you were maximizing your expected utility at that time.
mon's brother Andrew likes to come to Simon's apartment and watch movies on his 70-inch television, but being a broke college student, Andrew has very little extra money each month. Andrew would like to watch more than two movies per month, but all he has to offer Simon is $2 per month for the additional movies. Do you think Andrew's offer would convince Simon to pay for additional movies? If not, suggest an alternative that would achieve Andrew's goal.
No, however, it would be effective if Andrew paid Simon $9 per month for unlimited streaming.
Consider the following game. You pick a card from a deck and each time you select an ace, you get $260. For all other cards you must pay $13. What is the expected value of the game?
$8
Many colleges offer pass/fail classes. Use the ideas of adverse selection and moral hazardto explain why teachers in these classes find that pass/fail students rarely score at the top of the class.
A+B Students who are weaker in the subject tend to enroll in pass/fail classes. B. Students tend to shift their efforts to classes that are not graded pass/fail.
With ________, the quality of what is being offered in a transaction matters and is not easily demonstrated.
ADVERSE SELECTION
Mechanism design is used to
ALL ABOVE
All of the following statements about asymmetric information are true except:
Asymmetric information can only be solved through government intervention.
The market for pharmaceuticals purchased over the Internet.
Consumers cannot verify which companies selling pharmaceuticals are reliable due to imperfect information.
