Question 1

Which of the following best describes 'asymmetric information' in a market transaction?

Accepted Answer

One party in the transaction has more or better information than the other party.

Question 2

Suppose a used car market consists of 'peaches' (good cars) and 'lemons' (bad cars). If buyers cannot distinguish between the two, what is the likely outcome?

Accepted Answer

Only lemons will be sold, as sellers of peaches will not accept low offers.

Question 3

Adverse selection occurs when:

Accepted Answer

One party uses private information about a hidden characteristic to decide whether to participate in a transaction.

Question 4

In the context of health insurance, who is more likely to purchase insurance due to adverse selection?

Accepted Answer

High-risk individuals, because they expect higher medical expenses.

Question 5

Which of the following is an example of signaling in markets with asymmetric information?

Accepted Answer

A seller offering a warranty on a used car.

Question 6

Moral hazard is best described as:

Accepted Answer

A situation where one party takes hidden actions after a transaction that affect the other party.

Question 7

Which of the following is a principal-agent problem?

Accepted Answer

A worker (agent) is paid by a firm (principal) and may choose to work hard or shirk.

Question 8

Efficiency wages are used by employers to:

Accepted Answer

Increase worker motivation and productivity by paying above the market-clearing wage.

Question 9

Deductibles and co-payments in insurance contracts are designed to:

Accepted Answer

Reduce moral hazard by ensuring policyholders share some of the risk.

Question 10

Suppose an insurance company offers a plan charging $$450 per year, covering 100% of medical costs. Healthy people expect 200 in $$costs, unhealthy people expect $600. If only unhealthy people buy the plan, what is the insurance company's expected profit per customer?

Accepted Answer

$-150

Question 11

Which government policy could help reduce moral hazard in health insurance markets?

Accepted Answer

Taxing risky behavior and subsidizing healthy behavior.

Question 12

Why do new cars lose considerable value the minute they are driven off the lot, according to the economics of information?

Accepted Answer

Because buyers suspect the car may have hidden problems (asymmetric information).

Question 13

If a health insurance plan charges $$50 and covers 30% of medical costs, and a healthy person expects 200 in $$costs, what is their total expected out-of-pocket expense?

Accepted Answer

$110

Question 14

Which of the following best explains why adverse selection can lead to market failure?

Accepted Answer

It results in only high-risk or low-quality participants remaining in the market.

Question 15

A warranty on a used car is an example of:

Accepted Answer

A signal of product quality to reduce information asymmetry.

Question 16

If unemployment benefits are generous and last a long time, what moral hazard problem might arise?

Accepted Answer

Workers may have an incentive to remain unemployed longer.

Question 17

Which of the following is NOT a solution to the problems caused by asymmetric information?

Accepted Answer

Increasing information gaps.

Question 18

If a principal cannot perfectly monitor an agent’s actions, what is a likely outcome?

Accepted Answer

The agent may act in their own interest, not the principal’s.

Question 19

Which of the following best describes the effect of competition in health insurance markets with severe asymmetric information?

Accepted Answer

It may not improve market outcomes if insurers cannot distinguish between high- and low-risk individuals.

Question 20

Suppose a police force is small but punishments for crimes are severe. According to the economics of information, what is the likely effect?

Accepted Answer

Serious crimes will be deterred even if minor crimes go unpunished.

The Economics of Information (Microeconomics, Ch. 16) – Study Notes

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