Econ 351 Ch 17 Testbank
24) Explain the nature and consequences of asymmetric information for each of the following cases. What options are available in each instance to reduce the problem? a. medical insurance b. issuance of credit cards c. professional athletes d. market for used appliances
Answer: a. Medical insurance is susceptible to adverse selection, since unhealthy people are more likely to want insurance than healthy individuals. A premium based on the incidence of claims among the general population will be too low. Remedies include medical examinations, medical histories, and refusal to cover pre-existing conditions. b. The credit problem arises when all customers must be charged the same rate. Poor credit risks find the rate attractive and apply for credit in disproportionate numbers. The interest rate based on average bad loan rates will be too low. To protect from this bias, credit companies can share credit histories. c. Professional athletes become a problem when free agency is allowed. The athlete's existing team has more information regarding the players' health than a new team. The expectation is that free agent players have higher disability rates than renewed players. To protect against this problem, professional franchises should require medical examinations and insist on clauses that void the contract if medical conditions are concealed. d. Markets for used appliances can be segmented according to quality. Buyers have an incentive to regard all appliances as being low quality. This depresses the price and reduces the availability of high appliances relative to the number that would exist with better information. The main solution is for sellers of high quality articles to provide warranties.
1) The principal-agent problem in corporations exists because the managers of a firm A) may pursue their own goals even when the result is lower profit for owners. B) may know how to operate the business better than absentee owners do, and yet not be allowed to. C) are generally unable to do the monitoring that would result in the firm's avoiding moral hazard problems. D) are generally unable to do the monitoring that would result in the firm's avoiding adverse selection. E) are generally unable to monitor workers, who do not care about the profits due the managers.
Answer: A
14) Credit histories allow firms to A) identify high-risk borrowers, so they can be eliminated and interest rates kept down for others. B) increase the number of credit cards issued, and interest rates go up as a result. C) increase the number of credit cards issued, and interest rates go down as a result. D) lower the number of credit cards issued, and interest rates go up as a result. E) increase market power in the credit card industry, raising interest rates.
Answer: A
15) Medical histories used by insurance firms allow them to A) identify high-risk people, so they can be denied insurance and premiums kept down for low risk people. B) increase the number of policies issued, raising premiums as a result. C) increase the number of policies issued, lowering premiums as a result. D) lower the number of policies issued, raising premiums. E) increase market power in the insurance industry, raising premiums.
Answer: A
16) Because the presence of a warranty for a good is a signal that the good is of high quality, A) consumers are willing and able to pay more for a good that carries a warranty. B) consumers are willing to buy goods if and only if the goods come with warranties. C) producers do not need to charge extra for warranties. D) producers can use warranties to sort out high-risk customers. E) producers must make warranties available on all goods.
Answer: A
17.2 Market Signaling 1) If grades are to be a successful signal to potential employers of a student's qualities, then higher grades must be A) easier for high-productivity students to earn than for low-productivity students to earn. B) easier for low-productivity students to earn than for high-productivity students to earn. C) easy for employers to check. D) used for all future promotions within the firm. E) often referred to in the hiring process.
Answer: A
17.6 Asymmetric Information in Labor Markets: Efficiency Wage Theory 1) The "efficiency wage" is the wage at which A) employees have no incentive to shirk. B) employees have an incentive to do the optimal (positive) amount of shirking. C) the cost of looking for work is equal to the value of the leisure time for the unemployed individual. D) there is no unemployment. E) there is only frictional unemployment.
Answer: A
18) A bumper-to-bumper warranty on a used car is a signaling device that A) identifies a high-quality car as a high-quality car, because putting such a warranty on a low-quality car would be prohibitively costly. B) disguises a low-quality car as a high-quality car, and thus makes it easier to sell. C) is necessary in order to sell a low-quality car at all. Without it no one would risk buying the car. D) isn't necessary if there is a mix of high-quality and low-quality cars in the market. E) helps sellers determine whether the buyer is truly looking for a high-quality car.
Answer: A
21) Which of the following job market signals are less costly for high-quality workers to send than low-quality workers? A) Spending long hours at the office B) Sending emails to coworkers and supervisors at night and on weekends C) Leaving voice-mail message for colleagues before or after regular business hours D) all of the above
Answer: A
23) Job market signals like dressing well for interviews are not especially effective because: A) the cost of dressing well is about the same for high-quality and low-quality workers. B) many businesses have adopted casual office attire, so dressing well is not important to the firm. C) federal labor laws prohibit firms from using dress or appearance as an employment criterion. D) none of the above
Answer: A
24) Many business professionals constantly monitor their incoming email and text messages so they can appear to be alert and responsive, even at night and on weekends. Alternatively, some time management consultants recommend that business professionals should not constantly check for new messages because this practice distracts the worker from scheduled tasks that may have higher priority. The decision to check email or text messages less frequently may not harm the worker's salary if it is a: A) weak signal of worker ability. B) weak signal of cell phone strength. C) strong signal of worker ability. D) strong signal of ease of distraction.
Answer: A
3) When a moral hazard problem exists for automobile driving, the marginal cost of driving A) is lowered, and the amount of driving done is raised above the efficient level. B) is lowered, and the amount of driving done is lowered below the efficient level. C) is raised, and the amount of driving done is raised above the efficient level. D) is raised, and the amount of driving done is lowered below the efficient level. E) is raised above the efficient level, but market forces keep the total amount of driving is kept at the efficient level.
Answer: A
3) Which of the following statements is NOT a reason that the cost of a college education is greater for the low-productivity group than for the high-productivity group? A) The wages they give up by going to college instead of working will tend to be higher for them. B) They may have to pay for tutoring services or other extra help to accomplish the same educational goal. C) They may have to take remedial classes, which would increase the length of time it takes to accomplish the same goal. D) Even if they take no remedial classes, they may have to spend more time studying for each class, and the value of their leisure time needs to be considered in the calculation. E) Based on previous signaling, such as from their high school grades or SATs, they may receive less merit-based financial assistance, and thus be under a greater financial strain during their college years.
Answer: A
8) Firms that have several plants that produce the same or related products are said to be: A) horizontally integrated. B) vertically integrated. C) conglomerates. D) cooperatives.
Answer: A
For Group A the cost of attaining an educational level y is CA(y) = $6,000y and for Group B the cost of attaining that level is CB (y) = $10,000y. Employees will be offered $50,000 if they have y < y*, where y* is an education threshold determined by the employer. They will be offered $130,000 if they have y > y*. 6) Refer to Scenario 17.1. If the threshold educational level y* is set at 10, A) only individuals in Group A will attain it. B) only individuals in Group B will attain it. C) individuals in both groups will attain it. D) no individuals will attain it. E) some fraction of individuals in each group will attain it.
Answer: A
11) Augustus bought his BMW convertible as a new car in 1998 and knows that it is in excellent condition. He now wants to sell it and knows that there are many other similar cars on the used car market that are lemons. As a result: A) he should be able to sell my car at a premium price because of its excellent condition. B) he will have to accept a lower price for his car because buyers might think that it is a lemon. C) he will not be able to sell his car unless he offers some sort of guarantee. D) he will get the best price for his car by selling it to a dealer. Answer: B
Answer: B
19) A warranty is most valuable as a signaling device when A) the buyer has much more information about the product than the seller does. B) the seller has much more information about the product than the buyer does. C) the buyer has much more information about his or her own preferences than the seller does. D) neither the buyer nor the seller has good information about the product. E) neither the buyer nor the seller has good information about consumer preferences.
Answer: B
19) How do online auction sites like Ebay attempt to overcome the asymmetric information problems associated with goods that the buyer cannot personally inspect before purchase? A) The online auction firm only allows high-quality merchandise to be sold at their site. B) The previous performance (reputations) of the buyer and seller are posted for public review. C) Buyers can take receipt of any goods before they have to pay the seller. D) all of the above
Answer: B
2) If individuals are paid the wage at which the supply of labor is equal to the demand for labor, A) no unemployment exists, and workers have no incentive to shirk. B) no unemployment exists, and workers have an incentive to shirk. C) some unemployment still exists, but workers have no incentive to shirk. D) some unemployment still exists, but managers can tell whether or not workers are shirking.
Answer: B
22) The process by which sellers send signals to buyers conveying information about product quality is known as: A) asymmetric information. B) market signaling. C) a lemons problem. D) moral hazard.
Answer: B
3) Julia is a 28-year-old nonsmoking, non-drinking female of normal weight. Because of adverse selection in health insurance, A) She will be charged less for her premiums than people who are higher risks. B) She is less likely to buy health insurance than the average person, because policy premiums are based on expected medical expenditures of people who are less healthy than she is. C) When she get health insurance, she will be less likely to take care of herself. D) She must get health insurance early in life, and is likely to lose health insurance if she smokes, drinks to excess, or gains weight. E) She is more likely than the average person to buy health insurance, because she is more likely to be offered it.
Answer: B
3) The efficiency wage is A) lower than the market-clearing wage, to penalize shirking. B) higher than the market-clearing wage, to penalize shirking. C) lower than the market-clearing wage, to allow managers the resources to monitor shirking. D) higher than the market-clearing wage, to reward workers for informing on others who shirk. E) lower than the market-clearing wage, because of shirking done by managers.
Answer: B
4) John is a 55-year-old male smoker, about 50 pounds overweight, who has high blood sugar and drinks to excess a couple of times each month. Because of adverse selection in health insurance, A) John is less likely to buy health insurance than the average person, because the average person's policy premiums will be based on his risk, not the average risk. B) John is more likely to buy health insurance than the average person, because his policy premiums will be based on the average risk, not his personal risk. C) when John gets health insurance, he will be less likely to take care of himself. D) when John gets health insurance, he will be more likely to take care of himself. E) if John doesn't have health insurance already, he will not be able to get it.
Answer: B
4) The efficiency wage is A) a wage at which there is no unemployment, and shirking workers are not counted in the pool of total labor. B) a wage at which there is a positive amount of unemployment. Individuals who are fired for shirking will be penalized with a period of unemployment. C) a wage at which there is a shortage of labor. Firms who fire a worker for shirking will be able to hire another one easily. D) the wage that is paid to high-quality, non-shirking workers. Other workers are paid the market-clearing wage. E) the wage that subtracts the cost of shirking from the market-clearing wage to determine that which is really paid.
Answer: B
7) Suppose new electronic devices make it easier to monitor the effort levels of workers. What happens to the NSC curve in the efficiency wage model? A) Shifts upward B) Shifts downward C) Remains the same D) The NSC curve remains the same, and the labor supply curve shifts leftward because shirking workers will leave the labor force.
Answer: B
Scenario 17.1 Consider the information below: For Group A the cost of attaining an educational level y is CA(y) = $6,000y and for Group B the cost of attaining that level is CB (y) = $10,000y. Employees will be offered $50,000 if they have y < y*, where y* is an education threshold determined by the employer. They will be offered $130,000 if they have y > y*. 4) Refer to Scenario 17.1. The highest level of y* that can be set and still have the high-productivity people choose to meet it is A) 16. B) 13 1/3. C) 13. D) 8. E) 0.
Answer: B
12) When states make car insurance mandatory for all drivers, it A) raises rates for everyone because it brings bad drivers into the pool. B) raises rates for high-risk drivers. C) may lower rates for all drivers to the extent that it keeps low-risk drivers in the pool. D) prevents high-risk drivers from "selecting out," to the detriment of low-risk drivers. E) increases the amount of information available to insurers about the population.
Answer: C
13) When firms participate in group health insurance for all employees, it A) raises rates for everyone, because it brings unhealthy people into the pool. B) raises rates for unhealthy people. C) may lower rates for all people to the extent that it keeps healthy people in the pool. D) prevents unhealthy people from "selecting out," to the detriment of healthy people. E) increases the amount of information available to insurers about the population.
Answer: C
16) In the arena of asymmetric information, standardization (for example, menus at McDonald's restaurants) is a substitute for A) quality. B) government regulation. C) reputation of individual sellers. D) firms' distinguishing among buyers. E) firms' segregation of buyers.
Answer: C
17) Which of the following is TRUE about producers' willingness to offer warranties on products? A) Producers are equally likely to offer warranties on high-quality and low-quality goods. B) Producers are more likely to offer warranties on low-quality goods, because without the signal that the warranty provides, the low-quality good wouldn't sell. C) Producers are more likely to offer warranties on high-quality goods, because the expected cost of repairs is lower for those goods. D) Producers have an incentive to deal with third-party companies to provide the warranties, so that an "impartial" view of the product is given to the consumer. E) Producers will not offer warranties in any market that suffers from asymmetric information.
Answer: C
17.1 Quality Uncertainty and the Market for Lemons 1) Used cars sell for much less than new cars because A) of imperfect competition in the automobile industry. B) buyers know much more about the quality of used cars than sellers do. C) sellers know much more about the quality of used cars than buyers do. D) physical depreciation of used cars is very high. E) of licensing arrangements by the government.
Answer: C
17.5 Managerial Incentives in an Integrated Firm 1) Asymmetric information problems arise A) in horizontally integrated firms, but not vertically integrated firms. B) in vertically integrated firms, but not horizontally integrated firms. C) in both vertically and horizontally integrated firms. D) only in firms that do not have the advantage of either horizontal or vertical integration. E) only when a single firm is both horizontally and vertically integrated.
Answer: C
2) Managers' pursuit of which of the following objectives would NOT lead to a principal-agent problem in a corporation? A) The corporation's growth B) Increased market share for the corporation C) The maximum possible profit for the corporation D) A great "golden parachute" or retirement package E) Increased current salary and fringe benefits
Answer: C
2) What is the problem with paying plant managers in multi-plant firms according to the level of output they produce? A) Managers in low-cost or high-capacity plants could be penalized, in percentage terms, for their overproduction. B) The production problem in multi-plant firms is usually how to lower production to increase market power, not how to increase production. C) Managers in high-cost or low-capacity plants could be penalized for production constraints over which they have no control. D) Managers would have an incentive to understate the productive capacity of their plants. E) Managers would have an incentive to overstate the productive capacity of their plants.
Answer: C
2) Which of the following would be LEAST likely to contribute to a moral hazard problem among drivers? A) Provide medical coverage to all drivers, their passengers, and any and all individuals involved in the accident, no matter who was at fault. B) Provide medical coverage and car repair/replacement coverage to drivers, their passengers, and any and all individuals involved in the accident, no matter who was at fault. C) Modify all cars to remove the driver's seatbelt and the steering wheel air bag. D) Pass a law limiting the amount of damages that juries may award in accident cases. E) Make automobile insurance mandatory for all drivers.
Answer: C
20) Which of the following is TRUE about a college education as a signaling device? A) It is a useful signal only if individuals choose majors related to their ultimate field of employment. B) It is a useful signal only if a college education is open to all individuals, no matter what their previous level of educational accomplishment was. C) It is a useful signal whether or not people actually learn anything in college. D) It is a useful signal only if the job in question cannot be done without the preparatory coursework the college degree required. E) It is less and less a useful signal in the post-industrial economy, where the skill sets employers need change so rapidly.
Answer: C
21) How does the federal government avoid the asymmetric information problem associated with providing health care to people over 65 years of age? A) Health care is standardized and is the same for all people over 65 years of age. B) Health insurers rely on the reputation of the covered individuals. C) Participation in the Medicare program is mandatory for all people over 65 years of age. D) Health information about people enrolled in the Medicare program is publically available.
Answer: C
25) Over the past several decades, low-productivity and high-productivity workers in the US and other countries have tended to invest in their own human capital by completing more years of college than earlier generations. Which of the following reasons does NOT help to explain this trend? A) The cost of education for low-productivity workers has declined due to the emergence of online and other nontraditional programs. B) The earnings gap between workers with and without education has grown larger over time. C) The cost of education for high-productivity workers has increased over time. D) The benefit associated with increased education has increased over time.
Answer: C
4) If the moral hazard problem in automobile driving were to be eliminated, the marginal cost of driving would be A) lowered enough to pull the amount of driving back down to the efficient level. B) lowered enough to raise the amount of driving back up to the efficient level. C) raised enough to pull the amount of driving back down to the efficient level. D) raised enough to raise the amount of driving back up to the efficient level. E) lowered back down to the efficient level, relieving the stress on market forces.
Answer: C
4) The principal-agent problem of ownership vs. control of the corporation tends to get worse when A) stock in a corporation is held exclusively by a small number of people who control the company's day-to-day operations. B) stock in the company is tightly held, but there are some "outsider" stockholders. C) stock in the company is very diffusely held, with no individual or group having control over a large block of stock. D) managers have profit-sharing schemes as part of their incentive package. E) managers focus on maximizing the firm's profits, rather than the firm's market share.
Answer: C
4) The problem of asymmetric information in multi-plant firms involves A) only the problem of how to get managers to produce as much as possible. B) only the problem of how to get managers to produce the amount the larger firm wants them to, whether it be a lot or a little. C) both the problem of how to get managers to produce the appropriate amount and the problem of how to get them to accurately report their capacity. D) both the problem of how to get managers to produce the appropriate amount and the problem of how to get them to not sell that output outside of the firm. E) both the problems of vertical and horizontal integration with the rest of the firm.
Answer: C
6) The "no shirking constraint" (NSC) curve is A) downward-sloping to reflect the fact that at higher wages, firms will monitor workers more to see whether they are shirking. B) downward-sloping to reflect the fact that shirking tends to be higher in lower-paying industries. C) upward-sloping because at high levels of unemployment, workers will refrain from slacking without much other incentive. D) upward-sloping because at high levels of employment, many "slacking" individuals have been hired. E) vertical because the constraint represents the absolute amount of time a firm will tolerate workers' slacking without laying them off.
Answer: C
7) Assume that both high and low quality appliances are sold in the used appliance market. If we assume asymmetric information with sellers having more information regarding quality than buyers, which of the following is necessarily true? The A) fraction of high quality appliances will be greater than under perfect knowledge. B) fractions of high and low quality appliances will be the same as with perfect information. C) fraction of high quality appliances will be less than with perfect information. D) none of the above
Answer: C
8) Consider a market in which high-quality and low-quality television sets are sold. Before consumers make a purchase, they do not know the quality of the sets, but the sellers do know. As compared to a situation where both consumers and sellers know the quality of the sets, this situation would A) cause no change in the ratio of low to high-quality sets sold. B) increase the fraction of high-quality sets sold. C) increase the fraction of low-quality sets sold. D) cause the average price of goods sold to rise.
Answer: C
For Group A the cost of attaining an educational level y is CA(y) = $6,000y and for Group B the cost of attaining that level is CB (y) = $10,000y. Employees will be offered $50,000 if they have y < y*, where y* is an education threshold determined by the employer. They will be offered $130,000 if they have y > y*. 7) Refer to Scenario 17.1. If the threshold educational level y* is set at 7, A) only individuals in Group A will attain it. B) only individuals in Group B will attain it. C) individuals in both groups will attain it. D) no individuals will attain it. E) some fraction of individuals in each group will attain it.
Answer: C
10) Assume that a particular state has decided to outlaw the sharing of individuals' credit histories as an illegal invasion of privacy. As a result of this action we would expect the A) cost of borrowing money to rise. B) number of loans to unworthy credit risks to rise. C) problems of asymmetric information to become more severe. D) all of the above E) none of the above
Answer: D
17) You want to add a new room on your house, but you are not familiar with the local building contractors and are not sure who to consider for the job. If you ask your friends for referrals, you are using their past experience as a way to evaluate the ________ of the builders. A) efficiency wages B) moral hazard C) asymmetric information D) reputation
Answer: D
18) Over the past several years, the federal government has rescued a few financially distressed banks and other large private companies, and the key reasons for these actions is to stabilize financial markets and to prevent additional business failures that may arise from the original problem. However, critics of these interventions argue that these actions generate a moral hazard problem. Why? A) Government oversight of rescued firms is typically based on limited information, so the outcome is economically inefficient. B) Rescued firms will have a difficult time buying insurance in private markets, so the government will also have to insure the firm against losses from fire, theft, etc. C) Managers have more information about the financial strength of their firm than government officials, so the rescue attempts may be unnecessary. D) Managers may be more likely to invest in risky projects if they believe the government will save the firm in case of failure.
Answer: D
18) When asymmetric information problems drive high quality products from a market, we refer to this situation as: A) adverse selection. B) moral hazard. C) a lemons problem. D) A and C are correct. E) B and C are correct.
Answer: D
2) The problem of adverse selection in insurance results in a situation in which A) people choose inappropriate or inadequate coverage because they do not understand the complex information in the policies. B) people choose too much coverage because they do not understand the complex information in the policies. C) people choose too little coverage because they do not understand the complex information in the policies. D) unhealthy people become more likely to buy insurance than healthy people, which drives premiums up, which drives even more healthy people away from the market. E) healthy people become more likely to buy insurance than unhealthy people, which drives premiums up, which drives even more unhealthy people away from the market even though they are the ones who need it most.
Answer: D
20) In insurance markets, moral hazard creates economic inefficiency because: A) insurance companies are price setters rather than price takers. B) insurance products are not homogenous goods. C) there are many buyers but only a few sellers. D) insured individuals do not correctly perceive the costs or benefits of their actions.
Answer: D
20) In the text, the authors present evidence that the market for free agents in professional baseball is subject to the lemons problem. How could a prospective free agent overcome this problem when seeking a new contract? A) Agree to accept a lower salary with a new team. B) Rely on standardization to avoid the asymmetric information problem. C) Decide to negotiate only with their current team. D) Develop a reputation as a reliable and productive player.
Answer: D
3) What is the problem with paying plant managers in multi-plant firms according to how much each plant produces relative to its capacity? A) Managers in low-cost or high-capacity plants could be penalized, in percentage terms, for their overproduction. B) The production problem in multi-plant firms is usually how to lower production to increase market power, not how to increase production. C) Managers in high-cost or low-capacity plants could be penalized for production constraints over which they have no control. D) Managers would have an incentive to understate the productive capacity of their plants. E) Managers would have an incentive to overstate the productive capacity of their plants.
Answer: D
5) The problem of production in multi-plant firms with asymmetric information can be solved by paying the manager A) a piece rate, some constant amount per unit of output produced. B) a larger amount for each unit than was paid for the previous unit, to reflect increasing marginal cost. C) a smaller amount for each unit than was paid for the previous unit, to reflect decreasing marginal revenue. D) an annual bonus that increases with each unit of output up to capacity, and decreases with each unit of output past capacity. E) an annual bonus that is calculated decreases with each unit of output up to capacity, and increases with each unit of output past capacity.
Answer: D
6) When sellers have more information about products than buyers do, we would expect A) sellers to get higher prices for their goods than they could otherwise. B) buyers to pay lower prices for goods than they would otherwise. C) high-quality goods to drive low-quality goods out of the market. D) low-quality goods to drive high-quality goods out of the market.
Answer: D
For Group A the cost of attaining an educational level y is CA(y) = $6,000y and for Group B the cost of attaining that level is CB (y) = $10,000y. Employees will be offered $50,000 if they have y < y*, where y* is an education threshold determined by the employer. They will be offered $130,000 if they have y > y*. 5) Refer to Scenario 17.1. The lowest level of y* that can be set and still have only the high-productivity people meet it is A) 16. B) 13 1/3. C) 13. D) 8. E) 0.
Answer: D
For Group A the cost of attaining an educational level y is CA(y) = $6,000y and for Group B the cost of attaining that level is CB (y) = $10,000y. Employees will be offered $50,000 if they have y < y*, where y* is an education threshold determined by the employer. They will be offered $130,000 if they have y > y*.8) Refer to Scenario 17.1. If the threshold educational level y* is set at 14, A) only individuals in Group A will attain it. B) only individuals in Group B will attain it. C) individuals in both groups will attain it. D) no individuals will attain it. E) some fraction of individuals in each group will attain it.
Answer: D
17.3 Moral Hazard 1) In the insurance market, "moral hazard" refers to the problem that A) insurers can't tell high-risk customers from low-risk customers. B) high-risk customers have an incentive to give false signals to make themselves look like low-risk customers. C) companies may unfairly lump individuals together by race, sex, age or other characteristics in an attempt to use demographic data to pinpoint high-risk populations. D) individuals are willing and able to pay different amounts for insurance, but must all be charged the same amount. E) individuals may change their behavior after the insurance is bought, so that they behave in a more high-risk manner than they did before.
Answer: E
2) The completion of a degree or course of study is a good labor market signal A) only if what is learned in that educational process relates directly to the job the individual is being considered for. B) only if there is a positive correlation between academic success and wage income. C) primarily because individuals develop good habits in college that serve them well in other areas later on. D) because all individuals have the opportunity (in the United States) to pursue higher education. E) because people who possess the traits that make them more productive in the workplace have an easier time completing an education than those who don't.
Answer: E
3) The principal-agent problem of ownership vs. control of the corporation arises when owners and managers A) are the same people. B) pursue objectives that differ from those their customers wish them to pursue. C) pursue objectives that differ from those their workers wish them to pursue. D) pursue objectives that differ from those the government wishes them to pursue. E) pursue different objectives.
Answer: E
5) The problem of adverse selection in health insurance leads to a situation in which A) health insurance covers inappropriate items for the population it serves. B) overinsurance of the premium-paying population occurs. C) underinsurance of the premium-paying population occurs. D) the percentage of the premium-paying population that is healthy rises, squeezing unhealthy individuals out of the market. E) the percentage of the premium-paying population that is unhealthy rises, squeezing healthy individuals out of the market.
Answer: E
9) Which of the following represent examples of adverse selection? A) Unhealthy people are more likely to want health insurance. B) Careless drivers purchasing extra auto insurance. C) Risk averse individuals choosing to buy extra insurance. D) all of the above E) A and B only
Answer: E
26) In this problem, a labor market exists where employers hire and pay workers according to how much formal education workers possess. Education is a proxy for the level of productivity that employers can expect from workers. Therefore, employers follow a strategy in which they hire workers and pay salaries according to the following conditions: Degrees Above the Values of Post High School High School Level Education During Working Life, B(y) None 0 (y = 0 years) Associate's Degree $30,000 (y = 2 years) Bachelor's Degree $51,000 (y = 4 years) Master's Degree $58,000 (y = 6 years) Assume that there are only two types of worker abilities, those who are less productive (type L) and those who are highly productive (type H). The less productive workers have to study harder than highly productive workers in order to earn any degree. Consequently, the costs (including the psychic costs of study effort) of attaining various levels of education for these two types of employees are different. For less productive workers: CL(y) = $13,000y For highly productive workers: CH(y) = $10,000y a. Draw a diagram with years of education on the horizontal axis. Graph the benefits to education B(y) and the costs of education for each of the two types of workers. Discuss what level of education each type of worker should obtain. b. Now use the equations above to verify your answer from part (a) mathematically. c. Explain the value of formal education above the high school level in the market place to employers.
a. As shown in this figure, the benefits to education B(y) is a step function which increases in value at those values of y corresponding to each degree attained. The cost of education for each type of worker is a constant upward sloping line, and the steeper line is for the low productivity workers. As you can see, the net benefits of education B(y) - C(y) is greatest when the low type earns just an associate's degree and when the high type earns a bachelor's degree. Neither type should earn the master's degree. b. Workers should strive for the level of formal education that maximizes the net benefits, that is B(y) - C(y). First let us consider the low type, L: Should the associate's degree (y = 2) be obtained?: 13y = CL(y) < B(y) = 30 y < 30/13 = 2.3 Yes, the associate's degree should be obtained since 2 < 2.3. Should the bachelor's degree (y = 4) be obtained?: 13y < 51 y < 51/13 y < 3.9 No, the bachelor's degree should not be obtained since 4 is not less than 3.9. Should the master's degree (y = 6) be obtained?: 13y < 58 y < 58/13 y < 4.46 No, the master's degree should not be obtained since 6 is not less than 4.46. Now perform the same calculations for the high type of worker, H: Associate's degree (y =2 )?: 10y < 30 y < 3 Yes, the high type should obtain (at least) an associate's degree, since the net benefit is 30 - 20 = 10. Bachelor's degree (y = 4)?: 10y < 51 y < 5.1 Yes, the bachelor's degree should be obtained since 4 < 5.1 The net benefit is 51 - 40 = 11, so this choice is better than stopping with the associate's degree. Master's degree (y = 6)?: 10y < 58 y < 5.8 No, the master's degree should not be obtained since 6 is not less than 5.8. c. The formal education (earned degrees) above high school serves as a signal to employers as to the expected level of productivity of potential employees. Low levels of formal education indicate expected low productivity, and high levels of formal education indicate expected high productivity from the employee.
