Econ ch. 12 active learning Q's

Suppose Vinnie is looking for a month-long vacation rental in San Diego. The first vacation rental Vinnie finds costs $800 per month. If he looks for another vacation rental, there's a 75 percent chance he'll find another one for $800 per month and a 25 percent chance he'll find one for $600 per month. Other than price, all of the vacation rentals are identical. Vinnie's marginal cost of searching for an additional vacation rental is $45. For Vinnie, the expected value of searching for another vacation rental is: • A) $200. • B) $50. • C) $45. • D) $5.Answer: D

: If Vinnie searches for another vacation rental, there's a 75 percent chance he'll find another one that's the same price and a 25 percent chance he'll save $200. Thus, the expected value of search is: $5 = (0.75)($0) + (0.25)($200) - $45.

Conspicuous consumption is a more effective signal of ability for people who: • A) live in large cities instead of small towns. • B) already have well-established reputations. • C) live in small towns instead of large cities. • D) don't understand moral hazard.

Answer: A In small towns, people are more likely to know each other, so there is less uncertainty about people's ability.

The pattern in which insurance is purchased more frequently by those who are the most costly for companies to insure is referred to as: • A) adverse selection. • B) statistical discrimination. • C) risk aversion. • D) moral hazard.

Answer: A Adverse selection refers to the pattern in which insurance tends to be purchased disproportionately by those who are most costly for companies to insure.

To prospective employers, an honors degree from a highly selective college is: • A) a credible signal about whether a job applicant is intelligent and hardworking. • B) a credible signal about whether a job applicant has had a job before. • C) not a credible signal about whether a job applicant is intelligent and hardworking. • D) only a credible signal about a whether job applicant is intelligent and hardworking if the job requires a college degree.

Answer: A All else equal, people who are intelligent and hardworking will find it easier to graduate with honors from a highly selective college than those who are not. Thus, graduating with honors from a highly selective college is a costly-to-fake signal about whether an individual is intelligent and hardworking.

This graph illustrates the marginal costs and marginal benefits of acquiring information before making a major purchase. If the original curves are MB0 and MC0, the optimal quantity of information about this product is: • A)I1. • B)I2. • C)I3. • D)I4.

Answer: A Consumers should acquire information up to the point where the marginal benefit of additional information equals the marginal cost of additional information.

Carson and Fran are both thrill seekers. Carson has health insurance and Fran does not. One can predict that: • A) Fran will engage in fewer dangerous activities. • B) Carson will engage in fewer dangerous activities. • C) Carson and Fran will participate in the same number of dangerous activities. • D) Carson's health insurance will not affect Carson's behavior.

Answer: A Since Fran does not have health insurance, she would bear all of the cost of a negative event while Carson would have at least some of the cost of a negative event covered by insurance.

Suppose Ginger is going to buy a house and a dishwasher. Assuming the marginal cost of searching for both is the same, one can predict that Ginger will • A) spend more time searching for the house than the dishwasher. • B) spend more time searching for the dishwasher than the house. • C) spend equal amounts of time searching for the dishwasher and the house. • D) trust the information from her real estate agent but not from the dishwasher salesperson.

Answer: A The benefit of having more information tends to be greater for more expensive items that for cheap ones.

Morgan lives in San Francisco and likes to dine out. Morgan has noticed that prices at restaurants near popular tourist destinations in the city tend to be higher than at restaurants of the same quality in other neighborhoods. One reason for this is that: • A) search costs are higher for people who are unfamiliar with the area. • B) residents don't like to eat in restaurants frequented by tourists. • C) tourists don't worry about money while on vacation. • D) restaurant meals are a small fraction of the total cost of a vacation.

Answer: A The cost of acquiring information will be higher for tourists who are not familiar with their surroundings. The higher cost of searching means that tourists will spend less time searching for a better deal and will end up spending more because of it.

Curly is offered the following gamble: a 25 percent chance of winning $1,500 and a 75 percent chance of losing $500. This is a(n): • A) fair gamble. • B) unfair gamble. • C) almost-fair gamble. • D) better-than-fair gamble.

Answer: A The expected value of this gamble is: $0 = (0.25)($1,500) + (0.75)(-$500). Since the expected value of this gamble is zero, it is a fair gamble.

In which of the following markets is the presence of asymmetric information of little concern to the buyer? • A) The market for used textbooks • B) The market for used houses • C) The market for used computers • D) The market for used cars

Answer: A There is less uncertainty about the quality used textbooks than the other items listed. As a result, asymmetric information is less of an issue.

A 65 percent chance of winning $10 and a 35 percent chance of losing $5 would be classified as a(n) • A) better-than-fair gamble. • B) worse-than-fair gamble. • C) unfair gamble. • D) fair gamble.

Answer: A This would be a better-than-fair gamble because the expected value of the gamble is $4.75 = (0.65)($10) + (0.35)($5), which is greater than zero.

Suppose that there are two employers in Tinytown. CareCo offers a generous health insurance package to all employees, while ApathyInc pays slightly higher wages than CareCo, but does not offer health insurance. All else equal, a person who is unhealthy and expects to have high healthcare costs will: • A) prefer to work for CareCo. • B) stop going to the doctor. • C) be equally happy working for either firm. • D) prefer to work for ApathyInc.

Answer: A Those who are relatively unhealthy will benefit more from the health insurance policy at CareCo.

This graph illustrates the marginal costs and marginal benefits of acquiring information before making a major purchase. Suppose the marginal cost and marginal benefit curves were MC0 and MB0 several decades ago. However, because information about this product is now available online, the: • A) optimal amount of information will decrease. • B) optimal amount of information will increase. • C) optimal amount of information will stay the same, but it will cost less to acquire. • D) demand for information will increase.

Answer: B Being able to now acquire information at a lower cost online will shift MC curve to the right (for example, from MC0 to MC1), so that the optimal amount of information will increase.

Suppose that there are two types of houses for sale: those with solid foundations and those with cracked foundations. In all other respects, the two types of houses are identical. Houses with solid foundations are worth $200,000, while those with cracked foundations are worth $200,000 minus the $20,000 to fix the crack, or $180,000. Sellers know which type of house they have, but buyers cannot detect whether the foundation has a crack. Suppose that 80 percent of the houses for sale have a solid foundation and 20 percent of the houses for sale have a cracked foundation. If buyers are risk-neutral and know the that 80 percent of the houses for sale have a solid foundation while 20 percent have a cracked foundation, then how much will buyers be willing to pay for a house? • A) $200,000 • B) $196,000 • C) $180,000 • D) $160,000

Answer: B Buyers will be willing to pay the expected value of a house, which is $196,000 = (0.80)($200,000) + (0.20)($180,000).

One way sellers can credibly signal that they have a high-quality product is to: • A) sell very little of their product in order to create scarcity. • B) spend a lot of money on advertising. • C) lower their marginal cost of production. • D) simply tell buyers more about their product.

Answer: B Compared to a seller with high-quality product, a seller with a low-quality product is less likely to find it worthwhile to spend a lot of money on advertising because even if the seller with the low-quality product can convince buyers to buy their product once, they will be less likely to generate repeat sales than will a seller with a high-quality product. This makes expensive advertising a credible signal of quality.

• Better information about consumers' reservation prices generally leads to: • A) a reduction in producer surplus. • B) acquisition of goods by consumers who are willing to pay the highest price. • C) equitable distribution of goods among low income consumers. • D) acquisition of goods by consumers with the greatest need.

Answer: B Having information about buyers' reservation prices enables sellers to sell items to those who are willing to pay the highest price.

Alex just got a new car. Because Alex obtained full-coverage car insurance, Alex will have an incentive to ________ because of ________. • A) drive more cautiously than if he didn't have insurance; moral hazard • B) drive more cautiously than if he didn't have insurance; adverse selection • C) drive less cautiously than if he didn't have insurance; adverse selection • D) drive less cautiously than if he didn't have insurance; moral hazard

Answer: D If Alex has car insurance, then he has less incentive to drive cautiously.

Gasoline prices tend to be higher at stations that are just off the freeway than they are at stations in the middle of town. The most likely reason for this is that: • A) freeway exit stations sell a higher quality product. • B) people who buy gas at freeway exit stations tend to have higher search costs. • C) freeway exit stations are more likely to have an attached convenience store. • D) demand for gas at freeway exits is lower than it is in the middle of town.

Answer: B People who buy gas near a freeway exit are likely to be willing to pay for the convenient location so as to avoid having to drive more in an effort to find lower-priced gasoline.

Suppose Joe has a reliable two-year old Honda Civic that's in excellent condition and that he would be willing to sell for $13,000. Lauren, who is risk-neutral, is considering whether to buy Joe's car. She's willing to pay $14,000 for a two-year Honda Civic that is reliable and only $10,000 for one that's not reliable. Lauren cannot tell whether Joe's car is reliable, but she believes that only 20 percent of two-year old Hondas for sale in the market are reliable and that the other 80 percent are not reliable. Will Lauren buy Joe's car? • A) Yes, because Lauren is willing to pay $14,000 for a car that's reliable. • B) No, because Lauren will not be willing to pay Joe $13,000. • C) Maybe, because Lauren might be willing to pay as much as $14,000. • D) Yes, because Lauren will be willing to pay Joe more than $13,000.

Answer: B Since Lauren is risk-neutral, the most she's willing to pay for the car is its expected value, which is $10,800 = (0.20)($14,000) + (0.80)($10,000). Since this is less than $13,000, Joe will not be willing to sell Lauren his car.

Suppose Joe has a reliable two-year old Honda Civic that's in excellent condition and that he would be willing to sell for $13,000. Lauren, who is risk-neutral, is considering whether to buy Joe's car. She's willing to pay $14,000 for a two-year Honda Civic that is reliable and only $10,000 for one that's not reliable. Lauren cannot tell whether Joe's car is reliable, but she believes that only 20 percent of two-year old Hondas for sale in the market are reliable and that the other 80 percent are not reliable. To Lauren, Joe's car looks just like every other two-year Honda that's for sale. What's the most Lauren is willing to pay for Joe's car? • A) $10,000 • B) $10,800 • C) $13,000 • D) $14,000

Answer: B Since Lauren is risk-neutral, the most she's willing to pay for the car is its expected value, which is $10,800 = (0.20)($14,000) + (0.80)(10,000).

The lemons problem gives the owners of above- average-quality used cars an incentive to: • A) exaggerate the quality of their cars when selling them. • B) offer a warranty when selling their cars. • C) understate the true quality of their cars when selling them. • D) ask for a sales price that is higher than the blue book value of their car.

Answer: B Since a warranty is a credible signal of quality, the owners high- quality used cars will have an incentive to offer a warranty when selling their cars.

When an individual is judged by the characteristics of the groups to which he or she belongs rather than on his or her own characteristics, it is called: • A) adverse selection. • B) statistical discrimination. • C) the lemons model. • D) moral hazard.

Answer: B Statistical discrimination refers to the practice of making judgments about the quality of people, goods, or services based on the characteristics of the groups to which they belong.

• When auctions, such as those used on eBay, are used to sell a product, then: • A) information about consumers' true reservation prices is minimized. • B) information about consumers' true reservation prices is revealed. • C) consumers have an incentive to bid above their true reservation prices. • D) consumers have an incentive to bid below their true reservation prices.

Answer: B The bidding process will encourage buyers to bid up to their true reservation price.

Suppose that the salary range for recent college graduates with a bachelor's degree in economics is $30,000 to $50,000, with 25 percent of jobs offering $30,000 per year, 50 percent offering $40,000 per year and 25 percent offering $50,000 per year and that in all other respects, the jobs are equally satisfying. Assume that in this market, a job offer remains open for only a short time so that continuing to search requires an applicant to reject any current job offer. The expected starting salary for a college graduate with a bachelor's degree in economics is: • A) $30,000. • B) $40,000. • C) $45,000. • D) $50,000.

Answer: B The expected starting salary is $40,000 = (0.25)($30,000) + (0.50)($40,000) + (0.25)($50,000).

Alison decides to play the lottery. She has a 5 percent probability of winning $100 and a 95 percent probability of winning zero. The expected value of playing the lottery is: • A) $100. • B)$5. • C) $10. • D) $50.

Answer: B The expected value of this gamble is: $5 = (0.05)($100) + (0.95)($0)

The free-rider problem arises when people: • A) obtain a good for less than the market equilibrium price. • B) who do not pay for a good cannot be excluded from consuming it. • C) who do not pay for a good cannot consume it. • D) who pay for a good cannot consume it.

Answer: B The free-rider problem arises when too little of a good or service is produced because nonpayers cannon be excluded from using it.

A risk-neutral individual will: • A) accept only better-than-fair gambles. • B) see risk as neither good nor bad. • C) accept only gambles with an expected value of zero or greater. • D) accept only gambles with an expected value of zero.

Answer: C A risk neutral person will only accept gambles that are fair or better-than-fair (that is, gambles with an expected value of zero or greater than zero).

According to the theory of disappearing political discourse, politicians remain silent about issues because politicians: • A) are unsure of their opinions. • B) don't have enough information. • C) fear that if they speak out they will be misunderstood. • D) fear that voters do not fully understand the issues.

Answer: C According to the theory of disappearing political discourse, politicians remain silent about issues because they fear that if they take a firm stance on an issue, they will be misunderstood because voters will judge them based on the characteristics of others who have that same stance on the issue.

Information about the quality of a product is: A) intangible, and therefore not subject to economic principles. • B) impossible to objectively assess, and therefore not subject to economic principles. • C) both beneficial to have and costly to obtain, and therefore subject to economic principles. • D) subject to economic principles only when it is paid for, for example by subscribing to Consumer Reports or by hiring a financial advisor.

Answer: C Acquiring information is both beneficial and costly, so it is rational to obtain more only to the extent that the expected marginal benefit is greater than or equal to than the expected marginal cost.

Suppose that there are two types of houses for sale: those with solid foundations and those with cracked foundations. In all other respects, the two types of houses are identical. Houses with solid foundations are worth $200,000, while those with cracked foundations are worth $200,000 minus the $20,000 to fix the crack, or $180,000. Sellers know which type of house they have, but buyers cannot detect whether the foundation has a crack. Suppose that 80 percent of the houses for sale have a solid foundation and 20 percent of the houses for sale have a cracked foundation. If some of the owners of houses with solid foundations remove their houses from the market because they can't sell their house for a price that is as high as the value of their house, then: • A) buyers' reservation prices will rise. • B) the owners of houses with a cracked foundation will also take their houses off the market. • C) the proportion of homes for sale with a cracked foundation will rise. • D) the average sales price of a house will rise.

Answer: C As owners of houses with a solid foundation remove their houses from the market, a larger proportion of houses on the market will have a cracked foundation.

Sydney sells snow globes from a cart. When the cart is located on the sidewalk near a discount store, Sydney's customers have reservation prices of $5. When Sydney's cart is located on a sidewalk in an upscale mall, wealthier customers with reservation prices of $10 buy snow globes. Assume that Sydney can sell the same volume at either location and that marginal and average costs are $3 per globe at both locations. Total economic surplus will be maximized if Sydney: • A) alternates between the two locations and price discriminates. • B) sells only near the discount store and charges $5. • C) sells only in the upscale mall and charges $10. • D) alternates between the two locations and charges $5 at both locations.

Answer: C Given that Sydney's costs are the same at either location, Sydney's net benefit is maximized by selling the snow globes at the upscale mall because Sydney receives $10 instead of $5.

Dan owns an autographed copy of a Brittany Spears CD that he values at $100. If he sells the CD at the garage sale he's planning to hold in a few weeks, it will be sold to a buyer with a reservation price of $175. If he sells it on eBay, it will be sold to a buyer with a reservation price of $500. eBay will charge Dan $50 to auction the CD, which just covers eBay's opportunity cost of running the auction. Relative to selling the CD at his garage sale, auctioning the CD on eBay will lead: • A) to no change in total economic surplus. • B) total economic surplus to increase by $500. • C) total economic surplus to increase by $275. • D) total economic surplus to increase by $100.

Answer: C If Dan sells the CD at his garage sale, then total economic surplus will be $75 (= $175 - $100). If Dan sells the CD on eBay, then total economic surplus will be $350 (= $500 - $100 - $50). Thus, if Dan sells the CD on eBay, total economic surplus will increase by $275 (= $350 - $75).

Statistical discrimination in the automobile insurance industry means that young male drivers who drive ________ will pay ________ rates relative to the claims they generate. • A) carefully; lower • B) recklessly; higher • C) carefully; higher • D) slowly; lower

Answer: C Since insurance companies cannot tell which young male drivers drive carefully and which drive recklessly, insurance rates will be based on the driving behavior of the average young male.

In the market for used cars, the lemons model predicts that: • A) sellers are less likely to sell low-quality cars than high- quality cars. • B) buyers are more likely to overstate their reservation price. • C) sellers are more likely to sell low-quality cars than high- quality cars. • D) sellers are more likely to understate the condition of their cars.

Answer: C Since the sellers of high-quality cars will be unlikely to get their asking price in the presence of asymmetric information, they will have little incentive to sell high-quality cars.

The reason the marginal benefit of information curve is downward sloping is because • A) some information is useless. • B) most information is useless. • C) information adds less and less benefit as more of it is acquired. • D) there is only so much to learn about a product.

Answer: C The more information a person has, the less beneficial is having still more information

Pat goes to the local electronics store to learn about high- end audio equipment. The salesperson spends an hour talking with Pat and demonstrating equipment. Pat then leaves and orders an audio system on the Internet for $250 less than the price at the store. Pat's behavior: • A) is illegal. • B) is a form of statistical discrimination. • C) illustrates the free-rider problem. • D) illustrates the problem of adverse selection.

Answer: C The store provides valuable information to Pat, but Pat can buy his stereo elsewhere. That is, even though Pat doesn't have to pay for the information, he cannot be excluded from using it.

Insurance companies practice statistical discrimination because: • A) young males are willing to pay more for insurance than other groups. • B) the demand for insurance is very inelastic. • C) young males are more likely than other groups to generate insurance claims. • D) insurance markets aren't perfectly competitive.

Answer: C Young males are more likely than other groups to generate insurance claims, and since the insurance company can't tell whether any given young man is a risky driver, the company simply charges all men more for insurance.

When attorneys, accountants and other professionals wear expensive clothing, it: • A) only serves as a useful signal of ability if they already have well- established reputations. • B) does not serve as a credible signal of ability because anyone can wear nice clothes. • C) is a waste of money because professionals do not need to signal their ability. • D) can serve as a credible signal of ability.

Answer: D Buying expensive clothing is inherently costly, so it is a costly-to-fake signal of success.

Suppose you are planning to sell your house. You value your house at $200,000. If you do not hire a realtor, you will be able to sell your house to a buyer whose reservation price is $220,000. If you hire a realtor, you will be able to sell your house to a buyer whose reservation price is $250,000. Assume that the realtor's opportunity cost of negotiating the sale is $5,000. In this case, how much additional economic surplus is generated by using a realtor to sell your house? • A) None, because you value the house at $200,000 no matter who buys it. • B) $250,000. • C) $200,000. • D) $25,000.

Answer: D If you do not use a realtor, total economic surplus from the sale of your house will be $20,000 (= $220,000 - $200,000). If you use a realtor, total economic surplus will be $45,000 (= $250,000 - $200,000 - $5,000). Thus, using a realtor increases total economic surplus by $25,000.

The sum of the possible outcomes of a gamble multiplied by their respective probabilities is known as: • A) a fair gamble. • B) the variance of the gamble. • C) a better-than-fair gamble. • D) the expected value of the gamble.

Answer: D The expected value of a gamble is the sum of the possible outcomes of the gamble multiplied by their respective probabilities.

Suppose Jack just booked a ticket to fly home to see his family for Thanksgiving. When he purchases the ticket, he decides to purchase travel insurance that allows him to get a full refund on his ticket if he's too sick to travel. Knowing this, Jack doesn't bother to take care of himself in the weeks leading up to the trip, reasoning that if he ends up being too sick to travel, then he can always get a full refund. Jack's failure to take care of himself in the weeks leading up to his trip is an example of: • A) adverse selection. • B) the lemons model. • C) a positional externality. • D) moral hazard.

Answer: D This is an example of a moral hazard because after Jack insured himself against illness, he made less effort to protect his health.

In the absence of laws requiring individuals to purchase insurance, insurance is most attractive to: • A) the poor. • B) the wealthy. • C) those with lowest likelihood of filing a claim. • D) those with the highest likelihood of filing a claim.

Answer: D Those with the highest likelihood of filing a claim stand to gain the most from purchasing insurance.

In markets with incomplete information, middlemen tend to ________ total economic surplus by ________. • A) reduce; raising prices • B) reduce; giving misleading information • C) increase; raising prices • D) increase; matching sellers with buyers who have high reservation prices

Answer: D Total economic surplus is increased by middlemen being able to match sellers with buyers who have high reservation prices.