Chapter 19/Asymmetric Information
CHAPTER 19 Asymmetric Information
MULTIPLE CHOICE
Choose the one alternative that best completes the statement or answers the question.
1) Adverse selection can occur when
A) all persons involved in a transaction have full information.
B) one person has information not available to others.
C) post-agreement incentives result in workers shirking.
D) nobody has any information about a particular product.
Answer: B
Diff: 0
Topic: Problems Due to Asymmetric Information
2) Adverse selection occurs when
A) a person takes more risks that are not known to the life insurance company because he has life insurance.
B) a person buys life insurance because he has a risky lifestyle that is not known to the life insurance company.
C) a person is a risk lover.
D) pregnant women with health insurance make more doctor visits than uninsured pregnant women.
Answer: B
Diff: 1
Topic: Problems Due to Asymmetric Information
3) Adverse selection occurs when there is
A) full information.
B) unobserved behavior.
C) an unobserved characteristic.
D) a worker who shirks because his boss does not watch him.
Answer: C
Diff: 1
Topic: Problems Due to Asymmetric Information
4) If reckless drivers are more likely to buy automobile insurance than safe drivers are,
A) a moral hazard has occurred.
B) adverse selection has occurred.
C) the market for insurance is efficient.
D) then automobile insurance will be fairly priced.
Answer: B
Diff: 1
Topic: Problems Due to Asymmetric Information
5) Used car buyers will believe that a car is of good quality when the seller signals the car's high quality by offering a warranty when
A) a warranty on a lemon is costly to the seller.
B) warranties are offered on all cars.
C) warranties are only offered on lemons.
D) a warranty on a good car is a false signal.
Answer: A
Diff: 1
Topic: Responses to Adverse Selection
6) If the market interest rate is 5% and a bank advertises loans at 12%, the bank will receive
A) no applications.
B) applications from mostly low-risk borrowers.
C) applications from mostly high-risk borrowers.
D) a moral hazard.
Answer: C
Diff: 1
Topic: Responses to Adverse Selection
7) If a life insurance company does not require a medical exam of its policyholders, it is most likely that the company
A) charges above-average premiums.
B) charges below-average premiums.
C) charges no premiums.
D) has only very healthy policyholders.
Answer: A
Diff: 1
Topic: Responses to Adverse Selection
8) If a student achieves a high SAT score, this
A) sends a signal to a college that the applicant will be a good college student.
B) does not act as a screening device.
C) is a moral hazard.
D) provides a college no information.
Answer: A
Diff: 1
Topic: Responses to Adverse Selection
9) Life insurance companies often give applicants a physical examination to prevent
A) the person from dying before obtaining the policy.
B) signaling.
C) adverse selection.
D) profit maximization.
Answer: C
Diff: 0
Topic: Responses to Adverse Selection
10) In the automobile insurance market, adverse selection occurs when
A) drivers with greater risks will buy a policy with large deductibles.
B) drivers with greater risks will buy a policy with no deductibles.
C) uninsured drivers will drive recklessly.
D) insured drivers will drive recklessly.
Answer: B
Diff: 1
Topic: Responses to Adverse Selection
11) The requirement that all drivers must carry auto insurance reduces
A) moral hazard.
B) the effectiveness of signaling.
C) adverse selection.
D) the chance of auto accidents.
Answer: C
Diff: 0
Topic: Responses to Adverse Selection
12) If bad drivers can usually avoid being ticketed by the police, then insurance companies will
A) use one's driving record as a signal.
B) use one's driving record as a screening device.
C) not be able to use one's driving record as a screening device.
D) request driving records directly from the police and not from the individual applicant.
Answer: C
Diff: 1
Topic: Responses to Adverse Selection
13) A physical examination is not a good screening device for life insurance companies if
A) life-threatening diseases are usually undetected.
B) doctors cannot be easily bribed to write a good report.
C) medical history is a good predictor of life expectancy.
D) one's current state of health is a good predictor of life expectancy.
Answer: A
Diff: 1
Topic: Responses to Adverse Selection
Figure 19.1
14) The market for used cars is shown in Figure 19.1. Buyers cannot tell whether any given car is a lemon. Ten percent (10%) of all cars are lemons. Which of the following statements is true?
A) All of the cars will be sold.
B) No cars will be sold.
C) Only lemons will be sold.
D) Only good cars will be sold.
Answer: A
Diff: 1
Topic: How Ignorance about Quality Drives Out High-Quality Goods
15) The market for used cars is shown in Figure 19.1. Buyers cannot tell whether any given car is a lemon. Forty percent (40%) of all cars are lemons. Which of the following statements is true?
A) All of the cars will be sold.
B) No cars will be sold.
C) Only lemons will be sold.
D) Ten percent of the used cars sold will be lemons.
Answer: C
Diff: 1
Topic: How Ignorance about Quality Drives Out High-Quality Goods
16) The market for used cars is shown in Figure 19.1. Buyers cannot tell whether any given car is a lemon. Forty percent (40%) of all cars are lemons. Which of the following statements is true?
A) All of the cars will be sold at $1,600.
B) No cars will be sold.
C) Only lemons will be sold at $1,600.
D) Only lemons will be sold at $1,000.
Answer: D
Diff: 1
Topic: How Ignorance about Quality Drives Out High-Quality Goods
17) The market for used cars is shown in Figure 19.1. Buyers cannot tell whether any given car is a lemon. Ten percent (10%) of all cars are lemons. Which of the following statements is true?
A) All of the cars sell for $1,900.
B) Only lemons are sold for $1,900.
C) Only lemons are sold for $1,000.
D) Only good cars will be sold for $2,000.
Answer: A
Diff: 2
Topic: How Ignorance about Quality Drives Out High-Quality Goods
18) The market for used cars is shown in Figure 19.1. Buyers cannot tell whether any given car is a lemon. Ten percent (10%) of all cars are lemons. Which of the following statements is true?
A) Only lemons are sold for $1,900.
B) Only lemons are sold for $1,000.
C) Buyers of lemons will pay too much for their cars.
D) Buyers of good cars will pay too much for their cars.
Answer: C
Diff: 2
Topic: How Ignorance about Quality Drives Out High-Quality Goods
19) A consumer is likely to avoid adverse selection and get a high-quality lunch at
A) a snack bar at a traveling carnival.
B) a vendor who parks her cart at a different location every noon.
C) a restaurant in the center of a business district.
D) a restaurant located next door to Disneyland.
Answer: C
Diff: 1
Topic: How Ignorance about Quality Drives High-Quality Goods
20) Firms are able to price discriminate
A) when all customers are uninformed about quality differences.
B) when no customers are uninformed about quality differences.
C) when some customers are uninformed about quality differences.
D) when there is full information about quality available to all customers.
Answer: C
Diff: 1
Topic: Price Discrimination Due to False Beliefs about Quality
21) Selling the same product under different brand names allows a firm to price discriminate as long as
A) customers know the products are identical.
B) customers do not know the products are identical.
C) the products really are not the same.
D) the firm lets customers know that the products are identical.
Answer: B
Diff: 1
Topic: Price Discrimination Due to False Beliefs about Quality
22) Competitive firms are able to set price above marginal cost when
A) the markup is less than the cost of going to another store.
B) the markup is greater than the cost of going to another store.
C) all consumers have full information.
D) consumers know what other stores are charging.
Answer: A
Diff: 1
Topic: Market Power from Price Ignorance
23) When consumers have asymmetric information and when search costs and the number of firms are large, a single-price equilibrium in a competitive market
A) is impossible.
B) occurs when price equals average cost.
C) occurs when price equals marginal cost plus the search cost.
D) occurs where the price is the price a monopoly would set.
Answer: D
Diff: 1
Topic: Market Power from Price Ignorance
24) If there is zero search cost, then in the presence of asymmetric information, competitive firms will
A) charge the monopoly price.
B) charge the competitive price.
C) charge zero price.
D) shut down.
Answer: B
Diff: 1
Topic: Market Power from Price Ignorance
25) As long as there is asymmetric information among consumers and positive search cost, if price is below the monopoly price and the same across all firms, then a competitive firm
A) can always profit from raising its price.
B) can always profit from lowering its price.
C) can profit from raising its price but by no more than the search cost.
D) can profit from lowering its price but by no more than the search cost.
Answer: C
Diff: 1
Topic: Market Power from Price Ignorance
26) Empirical studies conclude that advertising
A) raises prices in all markets.
B) can reduce the prices of many goods.
C) reduces the prices on all goods.
D) has no impact on prices.
Answer: B
Diff: 1
Topic: Market Power from Price Ignorance
27) If consumers have limited information about price and search costs, then
A) the result must be that all firms will charge the same price.
B) the monopoly price must result.
C) the full-information, competitive price is not an equilibrium.
D) the difference in prices between firms will be greater than the search cost.
Answer: C
Diff: 1
Topic: Market Power from Price Ignorance
28) Firms underinvest in safety because
A) firms are not concerned with safety.
B) firms do not want their plants to be safe.
C) firms are risk averse.
D) firms do not enjoy all of the benefits from investments in safety.
Answer: D
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
Figure 19.2
29) Figure 19.2 shows the payoff to two firms in an industry deciding to make an investment in worker safety. The dominant strategy for each firm
A) is to do the opposite of the other firm.
B) is to make the investment.
C) is to not make the investment.
D) does not exist.
Answer: C
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
30) Figure 19.2 shows the payoff to two firms in an industry deciding to make an investment in worker safety. The Nash equilibrium
A) is for just one of the firms to make the investment.
B) is for both firms to make the investment.
C) is for neither firm to make the investment.
D) does not exist.
Answer: C
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
31) Figure 19.2 shows the payoff to two firms in an industry deciding to make an investment in worker safety. Neither firm will make the investment because
A) each can benefit from the other firm incurring the costs.
B) there is no benefit to making the investment.
C) each firm pays for the other firm's investment.
D) society does not care about worker safety.
Answer: A
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
32) Workers do not know the safety records at individual firms; they only know industry averages. As a result,
A) each firm tries to outdo each other in making safety improvements.
B) each firm has the incentive to be the safest in its industry.
C) the equilibrium level of safety is less than optimal.
D) the optimal level of safety is achieved.
Answer: C
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
33) Investment in safety at the firm level poses a prisoners' dilemma because
A) if each firm plays its dominant strategy, joint profits are maximized.
B) if each firm plays its dominant strategy, joint profits are not maximized.
C) neither firm has a dominant strategy.
D) the Nash equilibrium is not achieved.
Answer: B
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
34) Some software firms require that applicants have passed certain standardized certification tests before being hired. This policy is necessary when
A) cheap talk does not provide a credible signal.
B) cheap talk does provide a credible signal.
C) the interests of the firm and the applicant converge.
D) the applicant is honest about her abilities.
Answer: A
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
35) If getting accepted into college is very difficult because of high standards on intelligence and ability, but students learn absolutely nothing while in college, it is most likely that
A) they will not be hired upon graduation.
B) attendance sends a signal to employers regarding ability.
C) nobody would want to go to college.
D) a college degree is not a credible signal.
Answer: B
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
36) A pooling equilibrium occurs when
A) dissimilar workers are paid alike.
B) firms can distinguish between workers of different qualities.
C) workers of the same quality are paid different wages.
D) all workers are overpaid equally.
Answer: A
Diff: 0
Topic: Problems Arising from Ignorance when Hiring
37) If low-quality workers are unable to obtain a college degree, then a separating equilibrium can occur if
A) the cost of obtaining a degree is less than the wage premium paid to those who have obtained the degree.
B) the cost of obtaining a degree is greater than the wage premium paid to those who have obtained the degree.
C) the cost of obtaining a degree is zero.
D) the wage premium paid to those who have obtained the degree is positive.
Answer: A
Diff: 1
Topic: Problems Arising from Ignorance when Hiring
38) When relatively few workers have high ability,
A) they will settle for the average wage.
B) they will want to signal their ability.
C) the premium for high ability is less than when most workers have high ability.
D) they do not need to signal their ability.