Chapter 19

An all-you-can-eat buffet attracts two types of customers. Regular customers value the buffet at $20 and eat $5 of food in costs to the restaurant. Hungry customers value the buffet at $40 and eat $10 of food. If there are 100 of each type in the market for a buffet dinner, what is the restaurant's maximum profit? $2,500 $3,000 $4,500 $6,500

$3,000

An insurance company offers doctors malpractice insurance. Assume that malpractice claims against careful doctors cost $5,000 on average over the term of the policy and settling malpractice claims against reckless doctors costs $30,000. Doctors are risk-neutral and know whether they are reckless or careful, but the insurance company only knows that 10% of doctors are reckless. How much do insurance companies have to charge for malpractice insurance to break even? $5,000 $7,500 $27,500 $30,000

$30,000

Individuals who face greater risks a) are more likely to purchase insurance b) are less likely to purchase insurance c) are neither more nor less likely to purchase insurance d) are risk neutral

a) are more likely to purchase insurance

Adverse selection in insurance requires that a) potential customers face different levels risk b) potential customers facing more risk are no more interested in purchasing insurance c) people are not risk averse d) insurers can tell higher risk people from lower risk people

a) potential customers face different levels risk

Insurance companies create wealth by a) reducing the amount of risk that the risk averse must bear b) reducing the amount of risk that risk lovers must bear c) increasing the amount of risk that the risk averse must bear d) increasing the amount of risk that risk lovers must bear

a) reducing the amount of risk that the risk averse must bear

An individual who is a risk lover a) values a lottery at more than its expected value b) values a lottery at exactly its expected value c) values a lottery at less than its expected value d) tends to play lots of lotteries

a) values a lottery at more than its expected value

Which is NOT an example of signaling high quality in a social setting a) wearing everyday clothes to a job interview b) leaving a big tip for the waiter after a dinner date c) offering an expensive engagement ring to your bride d) Visiting the beauty salon before a big date

a) wearing everyday clothes to a job interview

Which firm is not dealing with adverse selection a) a manufacturer requires a 90 day probationary period for new employees b) a temporary clerical agency requires a typing test c) a manufacturer contracts with suppliers regardless of ISO 9000 status d) Smokers get the worse life insurance rates as non-smokers

c) a manufacturer contracts with suppliers regardless of ISO 9000 status

Screening is a) actions by the informed party to reveal her true risks b) actions by the informed party to conceal her true risks c) actions by the uninformed party to uncover the true risks d) actions by the uninformed party to conceal the true risks

c) actions by the uninformed party to uncover the true risks

To combat the problem of adverse selection, informed parties can employ techniques. more; signaling less; signaling equally; screening equally; signaling

more; signaling

The "lemons" problem is that a) cars of verifiable high quality are withheld from the used car market b) cars of verifiable low quality are withheld from the used car market c) cars of unverifiable high quality are withheld from the used car market d) cars of unverifiable low quality are withheld from the used car market

c) cars of unverifiable high quality are withheld from the used car market

Which is NOT an example of signaling high quality in a social setting a) wearing a business suit on a job interview b) leaving a big tip for the waiter after a dinner date c) offering a cheap engagement ring to your bride d) Visiting the beauty salon before a big date

c) offering a cheap engagement ring to your bride

Adverse selection in insurance requires that a) all people face the same risk b) potential customers facing more risk are no more interested in purchasing insurance c) people are risk averse d) insurers can tell higher risk people from lower risk people

c) people are risk averse

Someone who values a lottery at less than the expected value is a) a risk lover b) risk neutral c) risk averse d) one who tends to play lots of lotteries

c) risk averse

The following is an example of risk aversion a) those applying for a well-paid job tend to be the most qualified b) more reckless drivers opt for cars with fewer safety devices c) the contractor with the lowest bid for a is under-qualified d) Initial Public Offerings (IPOs) seek investors when prospects look good

c) the contractor with the lowest bid for a is under-qualified

An indication that Insurance companies anticipate adverse selection is a) they do not require a deductible b) they do not classify clients into different risk types according to their claim history c) they classify clients into different risk types according to pre-existing conditions d) they do not require a co-payment

c) they classify clients into different risk types according to pre-existing conditions

A risk averse individual a) values a lottery at more than its expected value b) values a lottery at exactly its expected value c) values a lottery at less than its expected value d) tends to play lots of lotteries

c) values a lottery at less than its expected value

Adverse selection is a) when people act differently because they are insured b) when more risk averse people want to be insured more c) when people at greater risk want to be insured more d) when your guess at a test question is wrong

c) when people at greater risk want to be insured more

If you are risk averse: a. You value a lottery at more than its expected value. b. You like to take gambles. c. A lottery is worth less to you than its expected value. d. You advertise your attitude toward risk

c. A lottery is worth less to you than its expected value.

Futures markets shift risk by: a. Farmers selling their crops when they are harvested and prices are certain. b. Agribusiness firms buying crops during the harvest at an uncertain price. c. Farmers selling their crops when they are planted and prices are certain. d. Agribusiness firms buying crops during harvest at a certain price.

c. Farmers selling their crops when they are planted and prices are certain.

Adverse selection is addressed in e-commerce markets by all of the following except: a. Extensive use of product reviews of products e.g. Yelp! And Trip Advisor. b. Selling on well-regarded platforms e.g. Amazon and Google market places. c. Forbidding escrow services d. Completing transactions through trusted third-party financial institutions e.g. Paypal, Visa.

c. Forbidding escrow services

If an insurance customer is risk averse, that the amount she would pay to avoid a 50% probability of a loss of $100 at: a. Less than $50. b. Exactly $50. c. More than $50. d. None of the above.

c. More than $50.

Screening: a. represents efforts made by the more informed party. b. is when the more informed party reveals her type by the choices she makes. c. is when the less informed party gathers information by the choices the more informed party makes. d. represents the more informed party being persuaded to reveal information about their type.

c. is when the less informed party gathers information by the choices the more informed party makes.

Two equal sized groups of potential insurance customers have risks of heart disease of 10% and 15% but you cannot tell them apart: a. you should set your price assuming that most purchasers will be from the low-risk group. b. you should set your price assuming that purchasers will be an average of both groups. c. you should set your price assuming that most purchasers will be from the high-risk group. d. you should price assuming more than 15% to make sure you earn a profit no matter who buys.

c. you should set your price assuming that most purchasers will be from the high-risk group.

Which is NOT an example of signaling high quality in a social setting a) wearing a business suit on a job interview b) leaving a big tip for the waiter after a dinner date c) offering an expensive engagement ring to your bride d) Doing messy chores before a big date

d) Doing messy chores before a big date

The following is an example of risk aversion a) those applying for a well-paid job tend to be the most qualified b) more reckless drivers opt for cars with fewer safety devices c) the contractor with the lowest bid for a is the most qualified d) Initial Public Offerings (IPOs) seek investors when prospects look poor

d) Initial Public Offerings (IPOs) seek investors when prospects look poor

Which is a screen against adverse selection a) Insurance companies require homeowners to have smoke detectors b) Rearview cameras in cars c) Installing engine monitors to track driving habits of the insured d) Prospective secretaries must take a typing test before being hired

d) Prospective secretaries must take a typing test before being hired

Which firm is not dealing with adverse selection a) a manufacturer requires a 90 day probationary period for new employees b) a temporary clerical agency requires a typing test c) a manufacturer requires suppliers to be ISO 9000 certified d) Smokers get the same life insurance rates as non-smokers

d) Smokers get the same life insurance rates as non-smokers

The reason some insurance customers are more eager to purchase insurance is a) they are more risk averse b) they are less risk averse c) they have a greater risk of making a claim d) a) and c)

d) a) and c)

Potential solutions to sell a high-quality used car include a) offering a warranty b) selling through a reputable dealer c) documenting the complete repair history d) all of the above

d) all of the above

Adverse selection in insurance requires that a) all people face the same risk b) potential customers facing more risk are no more interested in purchasing insurance c) people are not risk averse d) insurers cannot tell higher risk people from lower risk people

d) insurers cannot tell higher risk people from lower risk people

An indication that Insurance companies anticipate adverse selection is a) they do not require a deductible b) they do not classify clients into different risk types according to their claim history c) they do not classify clients into different risk types according to pre-existing conditions d) they require a co-payment

d) they require a co-payment

Most people buy insurance because they a) are risk lovers b) enjoy the gamble c) are risk neutral d) want to avoid gambles

d) want to avoid gambles

Those who choose to insure against theft: a. Reduce the risk they face. b. Pay insurance premiums greater than your expected loss. c. Are better off than if insurance was not available. d. All of the above

d. All of the above

For a screen to profitably inform the less-informed party about quality: a. It must be less expensive to screen than to put up with low quality counter-parties. b. The screen must divulge information about quality that is not commonly available otherwise. c. The differences in counter-party quality based on the screen should be large. d. All of the above.

d. All of the above.

For signaling to work in insurance: a. It must be profitable for low risk types to reveal their type. b. It must not be profitable for high risk types to mimic low risk signals. c. The insurer must be able to distinguish between high and low risk types based on the signal. d. All of the above.

d. All of the above.

E-commerce platforms, like Amazon.com, restrict their sites to high quality sellers by: a. Suing all firms with "too many" product reviews. b. Soliciting third-party reviews with compensation. c. Prominently displaying reviews that other customers considered less informative. d. Banning sellers from offering inducements for favorable reviews.

d. Banning sellers from offering inducements for favorable reviews.

For signalling to work: a. Sending the signal must be more expensive for high quality than low quality. b. It must be more expensive for high quality to send the signal than suffer being lumped together with low quality. c. It must be difficult for the less informed party to distinguish quality from the signal. d. None of the above.

d. None of the above.

All of the following are screens for quality except: a. Homeowner insurance companies using the zip code of the customer to determine the risk of theft. b. The human resources department requiring all new accounting hires to have passed the CPA exam. c. A car buyer of pre-own vehicles requiring a 30 day warranty. d. The health inspector requiring a bribe to pass a restaurant.

d. The health inspector requiring a bribe to pass a restaurant.

When farmers sell forward contracts in spring for the harvest they will reap in Autumn: a. Their planting decisions are riskier due to increased uncertainty. b. They accept a price higher than the expected price during harvest. c. They are worse off because the price today is less than what they could expect to sell their crops for in the autumn. d. They are better off because they have a preference for reducing risk.

d. They are better off because they have a preference for reducing risk.

The demand for insurance arises primarily from people who are risk-seeking. risk-averse. risk-neutral. None of the above.

risk-averse.

An insurance company suffers from adverse selection if safe customers are less likely to insure than risky customers. customers know their willingness to pay for insurance but the company does not. a customer takes on much greater risk because he is insured. its customers are risk-averse.

safe customers are less likely to insure than risky customers.

Which of the following is not an example of adverse selection? A business bets the proceeds of a bank loan on the next NFL game. An accident-prone driver buys auto insurance. A patient suffering from a terminal disease buys life insurance. A really hungry person decides to go to the all-you-can-eat buffet for dinner.

A business bets the proceeds of a bank loan on the next NFL game.

Which of the following is an example of adverse selection? A safe driver taking greater risk in a rental car than his own car. A terminally ill person purchasing life insurance. An employment contract encourages little effort on the part of employees. All of the above.

A terminally ill person purchasing life insurance.

Which of the following can be an example of a signal? An air-conditioning manufacturer offers a 50-year warranty. A lawyer offers to be paid only if the client wins. A student pursues an MBA. All of the above.

All of the above.

Which of the following is a potential solution to the adverse selection problem faced by insurance companies? Offer plans with different deductibles so that higher-risk customers accept higher deductibles. Create a national database of customers that allows companies to look up each person's historical risk. Mandate that every person purchase insurance. All of the above.

All of the above.

Which firm is not dealing with adverse selection a) a manufacturer forgoes a usual 90 day probationary period for new employees b) a temporary clerical agency requires a typing test c) a manufacturer requires suppliers to be ISO 9000 certified d) Smokers get the worse life insurance rates as non-smokers

a) a manufacturer forgoes a usual 90 day probationary period for new employees

Someone who values a lottery at more than the expected value is a) a risk lover b) risk neutral c) risk averse d) one who tends to play lots of lotteries

a) a risk lover

Signaling is a) actions by the informed party to reveal her true risks b) actions by the informed party to conceal her true risks c) actions by the uninformed party to uncover the true risks d) actions by the uninformed party to conceal the true risks

a) actions by the informed party to reveal her true risks

An indication that Insurance companies anticipate adverse selection is a) they require a deductible b) they do not classify clients into different risk types according to their claim history c) they do not classify clients into different risk types according to pre-existing conditions d) they do not require a co-payment

a) they require a deductible

The following is an example of risk aversion a) those applying for a well-paid job tend to be unqualified b) more reckless drivers opt for cars with fewer safety devices c) the contractor with the lowest bid for a is the most qualified d) Initial Public Offerings (IPOs) seek investors when prospects look good

a) those applying for a well-paid job tend to be unqualified

When offering insurance to groups with different risk profiles: a. Insurers tend to cater products to the higher risk group. b. Insurers serve the lower risk groups because they make fewer claims. c. Lower risk groups get more insurance coverage than higher risk groups. d. The higher risk groups are offered only get only partial insurance.

a. Insurers tend to cater products to the higher risk group.

Insurance markets create value because: a. The loss from a risk is greater for risk averse consumers than risk neutral insurance companies. b. The loss from a risk is greater for risk neutral consumers than risk averse insurance companies. c. The loss from a risk is less for risk averse consumers than risk neutral insurance companies. d. The loss from a risk is less for risk neutral consumers than risk averse insurance companies.

a. The loss from a risk is greater for risk averse consumers than risk neutral insurance companies.

If an insurance company cannot distinguish between the riskiness of potential customers, then: a. Their risk pool will have relatively more high risk customers than the population at large. b. They primarily sell to low risk customers. c. They earn more because they can overcharge the low risk customers. d. They can break at least even if they charge a rate based on the average risk in the population at large.

a. Their risk pool will have relatively more high risk customers than the population at large.

You are hiring for an entry-level tech support position where the starting salary range tends to be $40,000 to $50,000 per year. If you advertise a salary at the average of $45,000. a. Your applicant pool will be poor because better workers who know they are worth more than $45,000 will not apply. b. The applicant pool will look just like the talent pool. c. Your applicant pool will be great because the workers who apply will be worth more than $45,000. d. You should hire the first applicant to minimize hiring costs.

a. Your applicant pool will be poor because better workers who know they are worth more than $45,000 will not apply.

All of the following are examples of signals of quality except: a. choosing the lowest deductible insurance plan. b. a job applicant coming to the interview in a nice business suit. c. free product samples. d. money-back guarantees.

a. choosing the lowest deductible insurance plan.

Signaling: a. represents efforts to share information made by the more informed party. b. is when the less informed party signals her type by the choices she makes. c. is when the less informed party gathers information by the choices the more informed party makes. d. represents the less informed party being persuaded to reveal information about their type.

a. represents efforts to share information made by the more informed party.

Which firm is not dealing with adverse selection a) a manufacturer requires a 90 day probationary period for new employees b) a temporary clerical agency hires without verifying typing skills c) a manufacturer requires suppliers to be ISO 9000 certified d) Smokers get the worse life insurance rates as non-smokers

b) a temporary clerical agency hires without verifying typing skills

Individuals who are more risk averse a) buy less insurance b) buy more insurance c) are not more or less inclined to buy insurance d) are philosophically opposed to insurance

b) buy more insurance

The following is an example of risk aversion a) those applying for a well-paid job tend to be the most qualified b) more reckless drivers opt for cars with more safety devices c) the contractor with the lowest bid for a is the most qualified d) Initial Public Offerings (IPOs) seek investors when prospects look good

b) more reckless drivers opt for cars with more safety devices

Adverse selection in insurance requires that a) all people face the same risk b) potential customers facing more risk are more interested in purchasing insurance c) people are not risk averse d) insurers can tell higher risk people from lower risk people

b) potential customers facing more risk are more interested in purchasing insurance

Which is NOT an example of signaling high quality in a social setting a) wearing a business suit on a job interview b) scrimping on the tip for the waiter after a dinner date c) offering an expensive engagement ring to your bride d) Visiting the beauty salon before a big date

b) scrimping on the tip for the waiter after a dinner date

An indication that Insurance companies anticipate adverse selection is a) they do not require a deductible b) they classify clients into different risk types according to their claim history c) they do not classify clients into different risk types according to pre-existing conditions d) they do not require a co-payment

b) they classify clients into different risk types according to their claim history

People are more willing to buy an insurance product when: a. They are less risk averse. b. They face greater risk. c. They face less risk. d. They are no risk.

b. They face greater risk.

An employer faces two types of employees. Regular workers are 70% of the population and generate $100,000 in productivity. Exceptional workers are 30% of the population and generate $120,000 in productivity. Employees know their types and reject salaries below their productivity. If the employer offers a salary equal to the average productivity in the population, what will be the employer's per-employee profit? −$10,000 −$6,000 $0 $4,000

−$6,000