ECON PS10

Scenario: You walk onto a​ used-car lot to buy your first car.​ However, you are not sure about the quality of the cars in the lot and expect​ one-third of them to be of poor quality. Refer to the scenario above. Suppose you decide to buy a Toyota Corolla. You value the car for​ $10,000. You​ don't know​ it, but the car dealer values it for​ $8,500. If you have a zero value for​ poor-quality cars, what is the most that would you be willing to pay for the​ car?

$6,666.67

In the United​ States, the bulk of health care spending is paid by health insurance companies. Such a system is also called a​ third-party payer system where consumers of health care pay a nominal fee and the rest are paid by the health insurance provider. Why might such a system lead to an inefficient​ outcome?

Consumers have an incentive to​ over-consume health care services because they pay prices well below the cost of providing these services.

Briefly explain whether you agree with the following​ statement: ​"The reluctance of healthy young adults to buy medical insurance creates a moral hazard problem for insurance​ companies.

Disagree. Moral hazard becomes a problem after one purchases insurance. In this​ case, the reluctance of​ young, healthy adults to purchase insurance in the first place leads to an adverse selection problem.

Which of the following refers to the​ principal-agent problem in the market for health​ care?

Doctors pursuing their own interests rather than the interests of their patients.

Adverse selection

Is the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction.

​_____ refers to actions that one party in a transaction takes based on his private information and that affect the payoff to the other party.

Moral hazard

Asymmetric information

Occurs when one party to an economic transaction has less information than the other party.

Suppose a large firm allows its employees to choose whether to participate in its health insurance plan. The firm is trying to decide between two​ plans: Plan I has a low monthly premium but a high​ deductible, and Plan II has a high monthly premium but a low deductible. Under which plan is adverse selection likely to be a bigger​ problem?

Plan II because it is likely to draw participants who expect high medical costs. Healthy individuals who do not expect to consume much health care services will not be willing to pay the high premiums.

Moral hazard

Refers to actions people take after they have entered into a transaction that make the other party to the transaction worse off.

Principal-agent problem DEF

Results from agents pursuing their own interests rather than the interests of the principals who hired them.

Suppose that in a market for used​ cars, there are good used cars and bad used cars​ (lemons). Consumers are willing to pay as much as​ $6,000 for a good used car but only​ $1,000 for a lemon. Sellers of good used cars value their cars at​ $5,000 each and sellers of lemons value their cars at​ $800 each. Buyers cannot tell if a used car is reliable or is a lemon. Based on this​ information, what is the likely outcome in the market for used​ cars?

Sellers of good used cars will drop out of the market.

​________ refers to an action that an individual with private information takes in order to convince others about his information.

Signaling

Which of the following is an example of a​ principal-agent relationship?

The relationship between an employer and a worker

​Scenario: You walk onto a​ used-car lot to buy your first car.​ However, you are not sure about the quality of the cars in the lot and expect​ one-third of them to be of poor quality. Refer to the scenario above. Suppose you decide to buy a Toyota Corolla. You value the car for​ $10,000. You​ don't know​ it, but the car dealer values it for​ $8,500. Which of the following is true in this​ case?

There are gains from trade.

The marginal social benefit from vaccinations is greater than the marginal private benefit to people being vaccinated. (T or F)

True

________ are guarantees of quality issued directly by either the manufacturer or the seller.

Warranties

An insurance company is likely to attract customers like Clancy who want to purchase insurance because he knows better than the company that he is more likely to make a claim on a policy. What is the term used to describe the situation​ above?

adverse selection

You went to a craft show and paid an exorbitant price for an embroidered shawl that the seller said was​ hand-embroidered and had been imported from India. Several months​ later, you find a similar shawl in another showroom at a much lower price and found out that the one you bought was not an imported one. This is an example of​ ________ in the market for embroidered shawls.

asymmetric information

Claudia went to a department store to buy a few things for her new house. She found out that several items in the store were on discount and decided to make the most of the deals offered.​ However, as she started using the things that she​ bought, she realized that many of these items were defective. This happened due​ to:

asymmetric information.

Which of the following is an example of a way in which health insurance companies have dealt with the problem of adverse​ selection?

limiting insurance coverage on​ pre-existing conditions

Christine works as a receptionist in an office. She is not supposed to use the​ Wi-Fi connection provided by the company to access​ social-networking Web sites.​ However, she often uses the​ Wi-Fi to access these Web sites since her browsing activities are not monitored by her employer. This is an example of​ ________.

moral hazard

Governments are often forced to bail out large banks to prevent the entire economy from being affected adversely. This provision often encourages banks to invest in risky assets. This is an example of​ ________.

moral hazard

Linda noticed that ever since her brother bought theft insurance for his​ car, he keeps forgetting to lock his car. Her​ brother's behavior is an example of​ ________.

moral hazard

Mark works as a business development officer for a leading electronics company. His main task is to meet potential clients in their respective offices and try to enter into a business deal with them. Irrespective of the number of clients approached and deals​ made, Mark earns a fixed salary every month. Since his boss does not​ cross-check how many clients he meets in a​ day, Mark often does not meet all the clients that he is supposed to. His behavior is an example of​ ________.

moral hazard

More people started building houses in​ earthquake-prone regions when the government of Polonia launched an insurance program for houses in this region. This is an example of​ ________

moral hazard

Robert got a new job and relocated to a different city. He initially decided to stay in a small apartment close to his office.​ However, he decided to stay in a much bigger and costlier apartment when he found out that his employer would pay him a house rent allowance. This is an example of​ ________.

moral hazard

Sarah initially used her cell phone mostly to make important business calls.​ However, when she was informed that henceforth her phone bills would be reimbursed by her​ employer, she started using her cell phone to make frequent calls to her friends and relatives. This behavior is an example of​ ________.

moral hazard

Sometimes banks tend to invest in risky stocks since the deposits of their customers are insured by the Federal Deposit Insurance Committee. This behavior is an example of​ ________.

moral hazard

Which of the following terms refers to the problem in which one person with no deductible on his or her health insurance policy tends to engage in a less healthy lifestyle than another person with a high insurance​ deductible?

moral hazard

When people who buy insurance change their behavior after the purchase because they are protected from loss by the​ insurance, the insurance market is said to face the problem of

moral hazard.

Which of the following terms refers to what occurs when a person gets a vaccination against a disease and that action reduces the chances that other people will contract that​ disease?

positive externality

What can health insurance companies do to minimize problems associated with asymmetric information such as adverse selection or moral​ hazard? To deal with asymmetric​ information, insurance companies can

require policyholders to pay coinsurance

In the principal−agent ​relationship, the agent is

the person who is placed in control over resources that are not his own with a contractual obligation to use these resources in the interests of some other party.

Asymmetric information is a situation in which one party to an economic transaction has less information than the other party. Two types of problems associated with asymmetric information are adverse selection and moral hazard. Which of the following is an example of moral hazard. An example of moral hazard is...

those with health insurance smoking cigs

A fruit retailer buys 50 pounds of apples from the wholesale market every day. The retailer has observed that​ 20% of the apples bought each time are not of good quality. Since it is not possible for the retailer to check each apple before​ buying, how much should he pay for each pound if he values good apples at​ $1.40 per pound and has a value of zero for​ bad-quality apples?

​$1.12 per pound

A factory urgently needs to hire some workers. The factory owner is willing to pay a wage of​ $15 per hour to responsible workers and is unwilling to hire workers who require constant monitoring. On​ average, he expects 5 out of 10 workers who have come for an interview to be sincere. How much should he offer to pay the workers he​ hires?

​$7.50 per hour

Scenario: You walk onto a​ used-car lot to buy your first car.​ However, you are not sure about the quality of the cars in the lot and expect​ one-third of them to be of poor quality. Refer to the scenario above. Suppose you decide to buy a Toyota Corolla. You value the car for​ $10,000. You​ don't know​ it, but the car dealer values it for​ $8,500. What is the minimum price that the seller would accept for the​ car?

​$8,500

Which of the following is a prominent solution to adverse selection in used car​ markets?

​Third-party certification of used cars

Health insurance markets are likely to attract a disproportionate number of​ ________ individuals.

​high-risk