Econ Midterm 2: Ch. 12-18
Buyer's surplus
Buyer's value minus price
A consumer values a car at $20,000 and it costs a producer $15,000 to make the same car. If the transaction is completed at $18,000, the transaction will generate
$2,000 worth of buyer surplus and $3,000 of seller surplus.
A retailer has to pay $9 per hour to hire 13 workers. If the retailer only needs to hire 12 workers, a wage rate of $7 per hour is sufficient. What is the marginal cost of the 13th worker?
$33
A consumer values a car at $525,000 and a producer values the same car at $485,000. If sales tax is 8% and is levied on the seller, then the seller's bottom-line price is (rounded to the nearest thousand)
$527,000
Which is true of a Nash equilibrium?
The nash equilibrium is the likely outcome of the game
The expected value of an uncertain outcome is:
The sum of the probabilities times the random variables
If an insurance company cannot distinguish between the riskiness of potential customers, then:
Their risk pool will have relatively more high risk customers than the population at large.
if an insurance company cannot distinguish between the riskiness of potential customers, then:
Their risk pool will have relatively more high risk customers than the population at large.
When insurance companies cannot tell if customers are taking appropriate precautions: and all customers pay premiums higher than if the insurance company could detect the precautions taken
There is an unconsummated wealth transaction
When there are no systematic differences between treatment and control groups:
There is no selection bias
If moral hazard exists in insurance markets:
There is the potential for another transaction to be wealth-creating.
English auction (oral auction)
bidders offer successively higher prices and drop out until one remains.
Moral hazard occurs in lending because
borrowers have an incentive to fund riskier projects after the funds have been allocated.
For complementary, reduce price on ______ products to increase demand for both products.
both
1. Examples of insurance companies protecting themselves against moral hazard are:
buying locks for insured bicycles,
Food Fanatics caters meals where their cost of producing an extra meal is $25. Each of their meals is standard and sells for $20. At this rate what should the company do?
Produce fewer meals and increase their profit
E-commerce platforms, like Amazon.com, restrict their sites to high quality sellers by:
Banning sellers from offering inducements for favourable reviews.
Managers who can get more projects approved and oversee more assets get promoted faster. When making proposals to headquarters for new projects, these managers tend to develop support with analyses they perform.
Because they have an incentive to get projects approved, they may have created comparison groups that make their proposal look better than it is.
Foreclosure protection for homeowners and expanding borrower rights in the aftermath of the financial crisis:
Benefited irresponsible homeowners because they did not have to pay back the full loans on expensive houses
Second price auction
Bidders submit their bids without knowing the bids of other participants. The item is awarded to the highest bidder, but the winner pays the second-highest bid.
If you develop a cheap, new monitoring mechanism that reduces the amount of shirking by workers:
Both firms and workers are better off because the value of the additional work to the firm exceeds the cost to the worker.
When devising a strategy with considerable uncertainty:
develop a plan that leaves room for improvising when you experience an eventuality you did not anticipate.
Seller's surplus
difference between agreed on price and seller's value
When offering insurance to groups with different risk profiles
insurers tend to cater products to the higher risk group
If promotional expenditures make demand _______ elastic, then reduce price
more
charge a lower price to the group with the _____-elastic demand
more
senior citizens often have _____ price-elastic demand
more
· If MR>MC, sell ____
more
random variable
numerical outcomes that occur with different probabilities
For substitute, ____ price on the low margin (more price elastic) product
raise
For substitute, _____ price on both products to reduce price competition between them.
raise
randomized experiments
subjects of the experiment are assigned to the treatment group in a random or unbiased way
Selection bias occurs when
the treatment group differs systematically from the control group.
Ellie and Jacob are bargaining over the future profit of their lemonade stand. If Ellie has an outside option of $60 and Jacob has an outside option of $30, which of the following is most likely to be true?
Ellie will receive $30 more of the profit than Jacob
Example of moral hazard with sex
Engaging in riskier sexual practices because better HIV treatments are available
Insured Customers:
Exercise less care because they have less incentive to do so
Total costs increase from $1,500 to $1,800 when a firm increases output from 40 to 50 units. Which of the following is true if MC is constant?
FC = $300
Economists also:
Look for inefficiencies and suggest changes in public policy to correct
Moral Hazard occurs when
People are more likely to decide on a course of action when they do not bear the costs of the decision.
Moral Hazard occurs when:
People are more likely to decide on a course of action when they do not bear the costs of the decision.
Sally runs a chain of neighborhood apple cider stands. She purchases apples from the local grocery store and hires her brothers to staff the stands. Which of the following is true?
Sally is the principal and her brothers are the agents
Randomized experiments represent the "gold standard" in data analytics because:
Selection bias is eliminated since there are no systematic differences between treatment and control groups
An airline estimates that the potential cost of underpricing is less than the potential lost profit of unfilled seats. The airline should
Set a price below the "target price" so that expected demand is, on average, above capacity.
Dunkin' Donuts stores are independently owned by franchisees while Starbucks owns a majority of its stores which are run by salaried store managers. Which of the following does this imply?
Starbucks faces a greater adverse selection problem than Dunkin' Donuts.
When managers choose to allow workers to engage in some shirking, it is because:
The amount of workers would have to be compensated to stop shirking is not worth it.
At some company, the CEO is rewarded based on total company profit while a brand manager is rewarded based on total sales revenue of the brand. Which of the following is likely to be true?
The brand manager prefers a lower price than the CEO prefers
A government agency releases a report warning consumers about the negative health effects of eating beef. Which of the following changes in the beef market is most likely to occur following the release?
The demand curve will shift to the left, and price of beef will fall.
A lender offers a low interest rate to a firm because the proposed project has a high probability of success.
The firm will want to allocate the funds to a risker project.
What is not a screening for quality?
The health inspector requiring a bribe to pass a restaurant.
If the lender cannot prevent the borrower from using the proceeds of a loan as proposed:
The lender will make fewer loans
Insurance markets create value because:
The loss from a risk is greater for risk averse consumers than risk neutral insurance companies
In observational studies
The observations for the control group are determined after the treatment has been observed.
If moral hazard exists in insurance markets:.
There is the potential for another transaction to be wealth-creating
When farmers sell forward contracts in spring for the harvest they will reap in Autumn:
They are better off bc they have a preference for reducing risk
A firm produces 500 units per week. It hires 20 full-time workers (40 hours/week) at an hourly wage of $15. Raw materials are ordered weekly, and they cost $10 for every unit produced. The weekly cost of the rent payment for the factory is $2,250. How do the overall costs break down?
Total variable cost is $17,000; total fixed cost is $2,250; total cost is $19,250
Which of the following is a potential solution to a principal-agent incentive conflict?
Transfer information to a central decision maker
Observed effect
Treatment effect + Selection Bias
Progressive's Snapshot addresses moral hazard by:
Tying Customer's insurance premiums to how careful they drive
Variable Costs:
Vary with output
Buyer's value
WTP, top dollar
Individual value for goods and services are measured by
Willingness to pay
Shirking on the job is a version of moral hazard because:
Workers will exert less effort if there is no reward to exerting more effort
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.
Your applicant pool will be poor because better workers who know they are worth more than $45,000 will not apply
If you are risk averse:
a lottery is worth less to you than its expected value
arbitrage
can defeat a price discrimination scheme if enough of those who purchase at low prices resell to high-value consumers
Insurers protect themselves from moral hazard by:
charging premiums based on higher risks due to customers not taking precautions they would have if uninsured.
For __________, reduce price on both products to increase demand for both products.
complementary
Discounting is the inverse of _______
compounding
defend yourself from a Robinson-Patman lawsuit: you can claim that the price discount was _______
cost justified
the Robinson-Patman Act discourages
discounting
Non-strategic view of bargaining
does not focus on the explicit rules of the game to understand the likely outcome of the bargaining. Rather, it is the alternatives to agreement that determine the terms of any agreement.
The NPV rule illustrates the link between _______ and______
economic profit, investment decisions
Difference between economic and accounting costs:
economics considers both explicit and implicit, whereas accounting only uses implicit costs
incentive schemes are most effective when:
effort matters, little desire to do job, money boosts recipient's social status
Economists:
evaluate policies on whether they increase efficiency or decrease
outcome fairness
everyone has the same outcome
In the short-run, a firm's decision to shut-down should not take into consideration
fixed costs
3. When insurance companies cannot tell if customers are taking appropriate precautions:
getting insurance will cause customers to forgo taking precautions,
EVA
gives division managers incentives to incur capital expenditures if they earn more than they cost
onsider all costs and benefits that vary with the consequence of a decision. If you miss some, that is the:
hidden-cost fallacy.
Glum loser auction
high bidder gets item for free and everybody else pays the amount of his own bid.
If you adopt incentive pay, you get _______ productivity (procedural fairness) but also _______ inequality (outcome unfairness).
higher, greater
Taxes:
impede the movement of assets to higher-valued uses, reduce incentives to work, and decrease the number of wealth-creating transactions.
Wealth generating activities always:
increases total surplus
A new roasting innovation reduces the cost of producing coffee. As a result, the quantity of coffee ___________ and the price of coffee ________________.
increases, falls
When economists speak of "marginal," they mean
incremental
Assume a firm has the following cost and revenue characteristics at its current level of output: price = $10.00, average variable cost = $8.00, and average fixed cost = $4.00. This firm is
incurring a loss per unit of $2.00 but should continue to operate in the short run.
A price ceiling
is an implicit tax on producers and an implicit subsidy to consumers.
Buying a struggling firm and selling off its assets for more than purchase:
is creating value
baseball slugger drawing paying fans into the ballpark
is creating value
student increasing his decision making ability with an MBA
is creating value
Collusion 1
is more likely in small, frequent auctions than in big, frequent ones
Collusion 2
is more likely when winning bidders and winning bids are identified.
Screening
is when the less informed party gathers information by the choices the more informed party makes.
2. The biggest advantage of capitalism is that
it allows a person to follow their self interest
1. The biggest advantage of capitalism is that
it allows the market to self regulate
Deontologists:
judge actions as good or ethical by whether they conform to a set of principles, like the 10 Commandments or Golden Rule
Consequentialists
judge actions by their consequences. If consequence of action is good, action is good.
If the tax is ________ than the surplus, there is no transaction
larger
· If MC<MR, sell ____
less
Businesspeople:
look for inefficiencies and exploit them by moving assets from lower to higher value uses, and making money in the process
For substitute, raise price on the ______ margin (more price elastic) product
low
charge a ______ price to the group with the more-elastic demand
lower
When two firms, each producing one product, merge, the new entity should _____ prices if the products are complements and ______ prices if the products are substitutes.
lower, raise
Managers undertake an investment only if
marginal benefits are greater than marginal costs
If a firm's average cost is rising, then
marginal cost is greater than average cost
defend yourself from a Robinson-Patman lawsuit: you can claim that the price discount was given to ______the competition.
meet
Which of the following are examples of a price floor?
minimum wages
For substitute, raise price on the low margin (_____ price elastic) product
more
It can be illegal for a business to price discriminate when selling goods to other businesses unless
o price discounts are cost-justified, or o discounts are offered to meet competitors' prices.
hidden cost fallacy
occurs when you ignore relevant costs, those costs that do vary with the consequences of your decision.
Opportunity cost:
one alternative as the forgone opportunity to earn profit from the other
specific investment
one that is sunk or lacks value outside of a trading relationship
Projects with positive NPV create economic profit because they earn more than the company's ___________________________________
opportunity cost of capital
Uncertainty
outcomes that we cannot foresee or whose probabilities we cannot estimate
Price ceiling
outlaw trade at prices above the ceiling,
Price floor
outlaw trade at prices below the floor.
One of the most frequent causes of the sunk-cost fallacy is the _____ allocated to various activities within a company.
overhead
nash equilibrium
pair of strategies, one for each player, in which each strategy is a best response to the other
simultaneous move games
players do not observe the rival's decision before deciding on their own strategies.
sequential move games
players observe all prior decisions of the rival before deciding on a strategy
The marriage contract penalizes _________ (i.e., divorce), and this makes couples willing to _____ more in the marriage.
post-investment hold-up, invest
prohibition on buying and selling kidneys is a form of
price ceiling
The intended effect of tax is to ___________ ________ for the government, but unintended consequences of tax is that it ______ some wealth creating transactions
raise revenue, deters
For complementary, ______ price on both products to increase demand for both products.
reduce
For substitute, raise price on both products to ______ competition between them
reduce
If promotional expenditures make demand more elastic, then ________ price
reduce
Given that most people generally prefer to wear a bicycle helmet when riding, an increase in the price of bicycle helmets would tend to
reduce demand for bikes
· To induce higher effort, use incentives that _____marginal cost or _____ marginal benefit.
reduce, increase
If a firm charges prices closer to what consumers are willing to pay for a good, it ________ consumer surplus
reduces
Signaling
represents efforts to share information made by the more informed party.
Signaling:
represents efforts to share information made by the more informed party.
2. Examples of insurance companies protecting themselves against moral hazard are:
requiring repairs that homeowners make to their houses conform to building codes.
· MC typically ______ and MR typically______ with additional steps
rises, falls
The enemy of a good control is
selection bias
When the current price is higher than the equilibrium price,
sellers want to produce and sell more than buyers want to purchase.
For _____, raise price on both products to reduce price competition between them
substitute
For ________, raise price on the low margin (more price elastic) product
substitute
Gains from trade
sum of buyer and seller surplus, difference between seller's bottom line, and buyer's top dollar
If you take account of irrelevant costs or benefits, that is the
sunk- or fixed-cost fallacy.
Jet fuel prices have recently increased. This will most likely lead to which of the following changes?
supply for airplane trips decrease
An individual's value for a good or service is
the amount of money he or she is willing to pay for it.
A company is producing 15,000 units. At this output level, marginal revenue is $22, and the marginal cost is $18. The firm sells each unit for $48 and average total cost is $40. What can we conclude from this information?
the company needs to increase production
The key determinant of a careful observational study is:
the control group is created to mimic the treatment group without systematic differences.
A firm is thinking of hiring an additional worker to their organization who can increase total productivity by 100 units a week. The cost of hiring him is $1,500 per week. If the price of each unit is $12,
the firm should not hire the worker since MR<MC.
First price auction
the highest bidder wins the item at a price equal to the highest bid and you have to pay the amount you bid.
A manager of a clothing firm is deciding whether to add another factory in addition to one already in production. The manager would compare
the incremental benefit expected from the second factory to the cost of the second factory.
The higher the discount rates
the more value individuals place on current dollars.
Winner's Curse
the plight of the winning bidder who overestimates an asset's true value
2. For a screen to profitably inform the less-informed party about quality:
the screen must divulge info about quality that is not commonly available otherwise,
Common Value auction
the value is the same for each bidder, but no one knows what it is for sure. Each bidder has only an estimate of the unknown value.
when farmers sell forward contracts in spring for the harvest they will reap in Autumn:
they are better off because they have a preference for reducing risk
Risk
uncertainty that can be modeled with random variables
A way to deal with uncertainty is:
unexpected contingencies cause one to add enough flexibility into your strategy that permits responding as they emerge.
consumer surplus
value minus price
labor costs and ingredient costs are:
variable
Wealth is created when:
when assets move from lower to higher valued assets
Zero Sum Fallacy
when someone makes money someone else must be losing it
Wealth-creating transactions are more likely to occur
with property rights, strong contract enforcement, and in black markets
Seller's value
won't accept less than value, "cost"/"bottom line"
Two equal sized groups of potential insurance customers have risks of heart disease of 10% and 15% but you cannot tell them apart:
you should set your price assuming that most purchasers will be from the high-risk group.
IRR is the discount rate that sets NPV equal to ____
zero
procedural fairness
(everyone has the same opportunity)
not an example of signaling of quality
1Choosing the lowest deductible plan
If GDP is expected to increase at a steady rate of 3% per year, how many years would it take for living standards to double?
72/24 = 3
4. Examples of Moral Hazard are
A driver with all passenger airbags driving slightly more recklessly.
Examples of Moral Hazard are
A driver with all passenger airbags driving slightly more recklessly.
Which of the following will definitely result if there is both a leftward shift in demand and a leftward shift in supply?
A decrease in equilibrium quantity
Driving by a factory, you observe union workers on strike. Which of the following likely characterized the bargaining between the union and the factory's owners.
A lack of credibility
Which of the following combinations would definitely result in an increase in the equilibrium price in a market?
A leftward shift in supply and a rightward shift in demand
If you are risk averse:
A lottery is worth less to you than its expected value.
Price control:
A regulation that allows trade only at a certain price
Higher consumer incomes increase the demand for a particular good. How is this effect generally shown?
A rightward shift of the demand curve
Which of the following resolves a principal-agent moral hazard problem?
A university offers a bonus to its basketball coach if the team makes the NCAA tournament.
Which of the following is true about advertising?
Advertising can increase or decrease demand elasticity depending on the type of promotion.
Which of the following is an example of indirect price discrimination?
An early bird special at a restaurant before 6 pm
Which of the following are examples of moral hazard:
Apartment renters have more domestic accidents when they have renter's insurance
If price falls below _________, then you are losing money.
Average cost
Which of the following is true about costs associated with centralizing or decentralizing decision-making authority?
Centralized authority has costs associated with transferring information from agents while decentralized authority has costs associated with incentive schemes.
When implementing an incentive scheme, a manager should
Compensate employees for the extra risk
Cannibalization refers to
Customers switching from one company's product to the same company's substitute product
Which of the following is most likely to increase the amount you receive in a bargain?
Decreasing your opponent's gain
Which of the following is most likely to increase the amount you receive in a bargain?
Decreasing your opponents outside option
Recently, you observed both an increase in the price and quantity of wheat. These two outcomes could be the result of which of the following?
Demand curve for wheat shifting rightward
Which of the following factors would NOT cause a supply curve to shift to the right?
Demand increases for the product
Fixed costs:
Don't vary with output
1. Which of the following are examples of moral hazard?
Drivers with anti-lock brakes drive in ice and rain.
Which of the following are examples of moral hazard?
Drivers with anti-lock brakes drive in ice and rain.
EVA stands for
Economic Value Added
Futures markets shift risk by:
Farmers selling their crops when they are planted and prices are certain.
______ are irrelevant in extent decisions
Fixed Costs
_____________ does not affect effort.
Fixed cost or benefit
Adverse selection is addressed in e-commerce markets by all of the following except:
Forbidding escrow services?
Sealed first Price Auction
Highest bidder gets item at price equal to ohighest bid
NPV rule:
If the NPV of the sum of all the discounted CFs is larger than 0, than the project earns more than the cost of capital
Rule of 72:
If you invest at a return of rate r, divide 72 by r to get the number of years it takes to double your money
Principal agent relationships are generally characterized by:
Incentive conflicts between principals and agents
When offering insurance to groups with different risk profiles:
Insurers tend to cater products to the higher risk group
3. The biggest advantage of capitalism is that
It allows voluntary transactions, which create wealth
Which of the following is true about private-value auctions?
It is optimal to bid higher in a second-price auction than in a first-price auction.
1. For a screen to profitably inform the less-informed party about quality:
It must be less expensive to screen than to put up with low quality counter-parties,
For signaling to work in insurance:
It must be profitable for low-risk types to reveal their type, not profitable for high-risk types to mimic low-risk signals, the insurer must be able to distinguish between high and low risk types based on the signal
An employee who is gaming an incentive scheme is likely
Maximizing his or her own pay
1. The difference between moral hazard and adverse selection is:
Moral hazard has to do with hidden information about counter-party behaviors.
The difference between moral hazard and adverse selection is:
Moral hazard is when drivers are less careful of insured rental cars than their own vehicles.
If an insurance customer is risk averse, that the amount she would pay to avoid a 50% probability of a loss of $100 at:
More than $50
To avoid moral hazard in lending, lenders try to:
Place tight restrictions on how the lent funds can be used, require that a portion of the project is funded by the borrowers own funds, lend to borrowers who have assets to seize in case of default
Those who choose to insure against theft:
Reduce the risk they face, pay insurance premiums greater than your expected loss, are better off than if insurance was not available
marginal cost
additional cost incurred by producing and selling one more unit
marginal revenue
additional revenue gained from selling one more unit
price discrimination
allows a firm to sell items to low-value customers who otherwise would not purchase because the price is too high.
Second Price auction
also called Vickrey Auction
post investment hold up
an attempt by a trading partner to renegotiate the terms of trade after one party has made a sunk cost investment or investment specific to the relationship
2. When insurance companies cannot tell if customers are taking appropriate precautions:
and all customers pay premiums higher than if the insurance company could detect the precautions taken
3. For a screen to profitably inform the less-informed party about quality:
and the differences in counter-party quality based on the screen should be large.
A well designed incentive compensation scheme should always
anticipate profit-eroding gaming by employees.
Dutch Auction
auctioneer calls out a very high price and successively lowers it until an offer to buy is received.
strategic view of bargaining
bargaining as a game of chicken where the ability to commit to a position allows a player to capture the lion's share of the gains from trade.
