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Chapter 19/Asymmetric Information

CHAPTER 19 Asymmetric Information

MULTIPLE CHOICEChoose the one alternative that best completes the statement or answers the question.

1) A!erse se"ection can occ#r $hen

A) a"" persons in!o"!e in a transaction ha!e f#"" information%&) one person has information not a!ai"a'"e to others%C) post(areement incenti!es res#"t in $or*ers shir*in%+) no'oy has any information a'o#t a partic#"ar pro#ct%

Ans$er, &+iff, -Topic, Pro'"ems +#e to Asymmetric Information

.) A!erse se"ection occ#rs $henA) a person ta*es more ris*s that are not *no$n to the "ife ins#rance company 'eca#se he has

"ife ins#rance%&) a person '#ys "ife ins#rance 'eca#se he has a ris*y "ifesty"e that is not *no$n to the "ifeins#rance company%C) a person is a ris* "o!er%+) prenant $omen $ith hea"th ins#rance ma*e more octor !isits than #nins#re prenant$omen%

Ans$er, &+iff, 1Topic, Pro'"ems +#e to Asymmetric Information

) A!erse se"ection occ#rs $hen there isA) f#"" information%&) #no'ser!e 'eha!ior%C) an #no'ser!e characteristic%+) a $or*er $ho shir*s 'eca#se his 'oss oes not $atch him%

Ans$er, C+iff, 1Topic, Pro'"ems +#e to Asymmetric Information

0) If rec*"ess ri!ers are more "i*e"y to '#y a#tomo'i"e ins#rance than safe ri!ers are

A) a mora" ha2ar has occ#rre%&) a!erse se"ection has occ#rre%C) the mar*et for ins#rance is efficient%+) then a#tomo'i"e ins#rance $i"" 'e fair"y price%

Ans$er, &+iff, 1Topic, Pro'"ems +#e to Asymmetric Information

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3) Use car '#yers $i"" 'e"ie!e that a car is of oo 4#a"ity $hen the se""er sina"s the car5s hih4#a"ity 'y offerin a $arranty $henA) a $arranty on a "emon is cost"y to the se""er%&) $arranties are offere on a"" cars%C) $arranties are on"y offere on "emons%

+) a $arranty on a oo car is a fa"se sina"%

Ans$er, A+iff, 1Topic, Responses to A!erse 6e"ection

7) If the mar*et interest rate is 38 an a 'an* a!ertises "oans at 1.8 the 'an* $i"" recei!eA) no app"ications%&) app"ications from most"y "o$(ris* 'orro$ers%C) app"ications from most"y hih(ris* 'orro$ers%+) a mora" ha2ar%

Ans$er, C+iff, 1Topic, Responses to A!erse 6e"ection

) If a "ife ins#rance company oes not re4#ire a meica" e:am of its po"icyho"ers it is most"i*e"y that the companyA) chares a'o!e(a!erae premi#ms%&) chares 'e"o$(a!erae premi#ms%C) chares no premi#ms%+) has on"y !ery hea"thy po"icyho"ers%


;) If a st#ent achie!es a hih 6AT score thisA) sens a sina" to a co""ee that the app"icant $i"" 'e a oo co""ee st#ent%&) oes not act as a screenin e!ice%C) is a mora" ha2ar%+) pro!ies a co""ee no information%


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9) Life ins#rance companies often i!e app"icants a physica" e:amination to pre!entA) the person from yin 'efore o'tainin the po"icy%&) sina"in%C) a!erse se"ection%+) profit ma:imi2ation%

Ans$er, C+iff, -Topic, Responses to A!erse 6e"ection

1-) In the a#tomo'i"e ins#rance mar*et a!erse se"ection occ#rs $henA) ri!ers $ith reater ris*s $i"" '#y a po"icy $ith "are e#cti'"es%&) ri!ers $ith reater ris*s $i"" '#y a po"icy $ith no e#cti'"es%C) #nins#re ri!ers $i"" ri!e rec*"ess"y%+) ins#re ri!ers $i"" ri!e rec*"ess"y%

Ans$er, &+iff, 1Topic, Responses to A!erse 6e"ection

11) The re4#irement that a"" ri!ers m#st carry a#to ins#rance re#cesA) mora" ha2ar%&) the effecti!eness of sina"in%C) a!erse se"ection%+) the chance of a#to accients%

Ans$er, C+iff, -Topic, Responses to A!erse 6e"ection

1.) If 'a ri!ers can #s#a""y a!oi 'ein tic*ete 'y the po"ice then ins#rance companies $i""A) #se one5s ri!in recor as a sina"%&) #se one5s ri!in recor as a screenin e!ice%C) not 'e a'"e to #se one5s ri!in recor as a screenin e!ice%+) re4#est ri!in recors irect"y from the po"ice an not from the ini!i#a" app"icant%

Ans$er, C+iff, 1Topic, Responses to A!erse 6e"ection

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1) A physica" e:amination is not a oo screenin e!ice for "ife ins#rance companies ifA) "ife(threatenin iseases are #s#a""y #netecte%&) octors cannot 'e easi"y 'ri'e to $rite a oo report%C) meica" history is a oo preictor of "ife e:pectancy%+) one5s c#rrent state of hea"th is a oo preictor of "ife e:pectancy%


Figure 19.1

10) The mar*et for #se cars is sho$n in hich of the fo""o$in statements is tr#e?A) A"" of the cars $i"" 'e so"%&) @o cars $i"" 'e so"%C) On"y "emons $i"" 'e so"%+) On"y oo cars $i"" 'e so"%

Ans$er, A+iff, 1Topic, Ho$ Inorance a'o#t #a"ity +ri!es O#t Hih(#a"ity Boos

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13) The mar*et for #se cars is sho$n in hich of the fo""o$in statements istr#e?A) A"" of the cars $i"" 'e so"%&) @o cars $i"" 'e so"%

C) On"y "emons $i"" 'e so"%+) Ten percent of the #se cars so" $i"" 'e "emons%

Ans$er, C+iff, 1Topic, Ho$ Inorance a'o#t #a"ity +ri!es O#t Hih(#a"ity Boos

17) The mar*et for #se cars is sho$n in hich of the fo""o$in statements istr#e?A) A"" of the cars $i"" 'e so" at 17--%

&) @o cars $i"" 'e so"%C) On"y "emons $i"" 'e so" at 17--%+) On"y "emons $i"" 'e so" at 1---%

Ans$er, ++iff, 1Topic, Ho$ Inorance a'o#t #a"ity +ri!es O#t Hih(#a"ity Boos

1) The mar*et for #se cars is sho$n in hich of the fo""o$in statements is tr#e?A) A"" of the cars se"" for 19--%&) On"y "emons are so" for 19--%C) On"y "emons are so" for 1---%+) On"y oo cars $i"" 'e so" for .---%

Ans$er, A+iff, .Topic, Ho$ Inorance a'o#t #a"ity +ri!es O#t Hih(#a"ity Boos

1;) The mar*et for #se cars is sho$n in hich of the fo""o$in statements is tr#e?A) On"y "emons are so" for 19--%&) On"y "emons are so" for 1---%C) yers of "emons $i"" pay too m#ch for their cars%+) yers of oo cars $i"" pay too m#ch for their cars%

Ans$er, C+iff, .Topic, Ho$ Inorance a'o#t #a"ity +ri!es O#t Hih(#a"ity Boos

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19) A cons#mer is "i*e"y to a!oi a!erse se"ection an et a hih(4#a"ity "#nch atA) a snac* 'ar at a tra!e"in carni!a"%&) a !enor $ho par*s her cart at a ifferent "ocation e!ery noon%C) a resta#rant in the center of a '#siness istrict%+) a resta#rant "ocate ne:t oor to +isney"an%

Ans$er, C+iff, 1Topic, Ho$ Inorance a'o#t #a"ity +ri!es Hih(#a"ity Boos

.-)

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.) >hen cons#mers ha!e asymmetric information an $hen search costs an the n#m'er offirms are "are a sin"e(price e4#i"i'ri#m in a competiti!e mar*etA) is impossi'"e%&) occ#rs $hen price e4#a"s a!erae cost%C) occ#rs $hen price e4#a"s marina" cost p"#s the search cost%

+) occ#rs $here the price is the price a monopo"y $o#" set%

Ans$er, ++iff, 1Topic, Mar*et Po$er from Price Inorance

.0) If there is 2ero search cost then in the presence of asymmetric information competiti!e firms$i""A) chare the monopo"y price%&) chare the competiti!e price%C) chare 2ero price%

+) sh#t o$n%

Ans$er, &+iff, 1Topic, Mar*et Po$er from Price Inorance

.3) As "on as there is asymmetric information amon cons#mers an positi!e search cost ifprice is 'e"o$ the monopo"y price an the same across a"" firms then a competiti!e firmA) can a"$ays profit from raisin its price%&) can a"$ays profit from "o$erin its price%C) can profit from raisin its price '#t 'y no more than the search cost%+) can profit from "o$erin its price '#t 'y no more than the search cost%

Ans$er, C+iff, 1Topic, Mar*et Po$er from Price Inorance

.7) Empirica" st#ies conc"#e that a!ertisinA) raises prices in a"" mar*ets%&) can re#ce the prices of many oos%C) re#ces the prices on a"" oos%+) has no impact on prices%

Ans$er, &+iff, 1Topic, Mar*et Po$er from Price Inorance

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.) If cons#mers ha!e "imite information a'o#t price an search costs thenA) the res#"t m#st 'e that a"" firms $i"" chare the same price%&) the monopo"y price m#st res#"t%C) the f#""(information competiti!e price is not an e4#i"i'ri#m%+) the ifference in prices 'et$een firms $i"" 'e reater than the search cost%

Ans$er, C+iff, 1Topic, Mar*et Po$er from Price Inorance

.;)

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-)

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0) 6ome soft$are firms re4#ire that app"icants ha!e passe certain stanari2e certificationtests 'efore 'ein hire% This po"icy is necessary $henA) cheap ta"* oes not pro!ie a crei'"e sina"%&) cheap ta"* oes pro!ie a crei'"e sina"%C) the interests of the firm an the app"icant con!ere%

+) the app"icant is honest a'o#t her a'i"ities%

Ans$er, A+iff, 1Topic, Pro'"ems Arisin from Inorance $hen Hirin

3) If ettin accepte into co""ee is !ery iffic#"t 'eca#se of hih stanars on inte""ience ana'i"ity '#t st#ents "earn a'so"#te"y nothin $hi"e in co""ee it is most "i*e"y thatA) they $i"" not 'e hire #pon ra#ation%&) attenance sens a sina" to emp"oyers rearin a'i"ity%C) no'oy $o#" $ant to o to co""ee%

+) a co""ee eree is not a crei'"e sina"%

Ans$er, &+iff, 1Topic, Pro'"ems Arisin from Inorance $hen Hirin

7) A poo"in e4#i"i'ri#m occ#rs $henA) issimi"ar $or*ers are pai a"i*e%&) firms can istin#ish 'et$een $or*ers of ifferent 4#a"ities%C) $or*ers of the same 4#a"ity are pai ifferent $aes%+) a"" $or*ers are o!erpai e4#a""y%

Ans$er, A+iff, -Topic, Pro'"ems Arisin from Inorance $hen Hirin

) If "o$(4#a"ity $or*ers are #na'"e to o'tain a co""ee eree then a separatin e4#i"i'ri#mcan occ#r ifA) the cost of o'tainin a eree is "ess than the $ae premi#m pai to those $ho ha!eo'taine the eree%&) the cost of o'tainin a eree is reater than the $ae premi#m pai to those $ho ha!eo'taine the eree%C) the cost of o'tainin a eree is 2ero%+) the $ae premi#m pai to those $ho ha!e o'taine the eree is positi!e%


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;) >hen re"ati!e"y fe$ $or*ers ha!e hih a'i"ityA) they $i"" sett"e for the a!erae $ae%&) they $i"" $ant to sina" their a'i"ity%C) the premi#m for hih a'i"ity is "ess than $hen most $or*ers ha!e hih a'i"ity%+) they o not nee to sina" their a'i"ity%


9) If a co""ee eree is #se to sina" hih a'i"ity '#t the cost of a co""ee eree is re"ati!ehihA) a separatin e4#i"i'ri#m is achie!e%&) a poo"in e4#i"i'ri#m is achie!e%C) e!en "o$(a'i"ity $or*ers $i"" atten co""ee%+) the share of hih(a'i"ity $or*ers m#st 'e 1%


0-) 6creenin an sina"in in the "a'or mar*et are inefficientA) #n"ess co""ee costs are re"ati!e"y "o$%&) #n"ess they res#"t in a 'etter Do' match%C) 'eca#se the 'enefits are sprea o#t o!er many firms%+) 'eca#se they raise the $ae pai to a"" $or*ers%


01) Cheap ta"* $or*s at p"acin $or*ers in the riht Do' as "on asA) the interests of the $or*er an the firm coincie%&) a"" $or*ers $ant the most emanin Do's rear"ess of their a'i"ities%C) $or*ers ha!e ifferent a'i"ity "e!e"s that are #n*no$n to firms%+) firms are not profit ma:imi2ers%


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0.) A#to ins#rance rates are "o$er for yo#n $omen re"ati!e to yo#n men% An#n#s#a""y rec*"ess yo#n $oman ri!er 'enefits from thisA) statistica" iscrimination%&) sina"%C) screenin%

+) maDority !otin%


TRUE/

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3) In the to#rist(trap moe" a cons#mer miht pay more than marina" cost for a oo so" in acompetiti!e mar*et if the cost of possi'"y finin the oo cheaper is more than the mar*#po!er marina" cost%

Ans$er, Tr#e% The cons#mer ma*es her ecision at the marin% If the cost of finin acheaper price is reater than the possi'"e sa!ins then it oes not pay to search any f#rther%+iff, 1Topic, Mar*et Po$er from Price Inorance

PRO&LEM6

1) E:p"ain $hat may occ#r $hen a '#yer an a se""er ha!e #ne4#a" amo#nts of "imiteinformation% +escri'e t$o ifferent types of pro'"ems that may arise $hen asymmetricinformation e:ists%

Ans$er, Asymmetric information may "ea to opport#nistic 'eha!ior $here the informeperson 'enefits at the e:pense of the person $ith "ess information% A!erse se"ection mayocc#r $here the informe person 'enefits form the "ess informe person not *no$in a'o#tan #no'ser!e characteristic of the informe person% Mora" ha2ar may occ#r if the informeperson ta*es a!antae of the "ess informe person thro#h an #no'ser!e action%+iff, 1Topic, Pro'"ems +#e to Asymmetric Information

.) The FG Co% is hirin sa"espersons% They $i"" 'e pai a !ery attracti!e ho#r"y rate that isinepenent of ho$ m#ch they se""% +escri'e an a!erse se"ection that $o#" ta*e p"ace%+escri'e a mora" ha2ar that $o#" ta*e p"ace%

Ans$er, The a!erse se"ection occ#rs $hen on"y 'e"o$(a!erae sa"espeop"e app"y for theDo'% A'o!e(a!erae sa"espeop"e *no$ they are oo an $o#" prefer a commission so thattheir income increases $ith their performance% &e"o$(a!erae sa"espeop"e o not "i*e to$or* on commission 'eca#se it "o$ers their income% The mora" ha2ar occ#rs $hen thesa"espeop"e once hire are "ess pro#cti!e than they $o#" 'e if they $ere pai acommission instea of an ho#r"y $ae%+iff, -Topic, Pro'"ems +#e to Asymmetric Information

) Ho$ can a $arranty at the se""er5s e:pense sina" that a pro#ct is of hih 4#a"ity?

Ans$er, If the pro#ct is of "o$ 4#a"ity the $arranty $o#" 'e !ery cost"y to the se""er sincea "o$(4#a"ity pro#ct $o#" nee more repairs than a hih(4#a"ity pro#ct%+iff, -Topic, Responses to A!erse 6e"ection

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0) E:p"ain $hy some peop"e $ho are app"yin for a Do' at a 'an* ress #p arri!eear"y an ha!e their paper$or* neat"y comp"ete for the Do' inter!ie$%

Ans$er, They are tryin to e"iminate a!erse se"ection% These peop"e are tryin to sina" thatthey $o#" 'e a hih(4#a"ity $or*er for the position at the 'an*%

+iff, 1Topic, Responses to A!erse 6e"ection

Figure 19.1

3) The mar*et for #se cars is sho$n in hat !a"#e of is necessary for a"" cars

to 'e so"?

Ans$er, The se""ers of oo cars ha!e a reser!ation price of 1;--% 6ettin 1;-- e4#a" to

the e:pecte !a"#e of a car yie"s 1;-- =J 1---) K ==1 ) J .---) .--- =J

1---)% 6o .-8% Th#s if .-8 a"" cars $i"" 'e so"%

+iff, 1Topic, Ho$ Inorance a'o#t #a"ity +ri!es O#t Hih(#a"ity Boos

7) The mar*et for #se cars is sho$n in

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) The mar*et for #se cars is sho$n in

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Figure 19.1

11) T$o firms A an & are face $ith a ecision on ma*in in!estments in safety% They eachc#rrent"y earn profit of 3-- each% A safety in!estment $o#" cost 1-- pai 'y the firm thatma*es the in!estment an $o#" "o$er 'oth firms5 "a'or costs 'y 3 per firm% +ra$ thepayoff matri: for this ame an etermine the @ash e4#i"i'ri#m% +oes it ma*e sense for thefirms in the in#stry to as* the o!ernment to force them to ma*e the in!estment? E:p"ain%

Ans$er, 6ee

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1-8 chance he is "yin% Bi!en the payoff matri: in i"" there 'e a poo"in e4#i"i'ri#mor a separatin e4#i"i'ri#m?

Ans$er, Uner a poo"in e4#i"i'ri#m a"" $or*ers are pai =%1 J ----) K =%9 J .----) .1---% The hih(a'i"ity $or*er m#st pay 11--- to ain 9---% 6he $i"" not so apoo"in e4#i"i'ri#m is possi'"e% Uner a separatin e4#i"i'ri#m the hih(a'i"ity $or*er m#stpay 11--- to ain 1----% 6he $i"" not so a separatin e4#i"i'ri#m is not possi'"e%+iff, 1Topic, Pro'"ems Arisin from Inorance $hen Hirin

10) The cost c of a co""ee e#cation that ser!es on"y as a sina" of a hih(4#a"ity$or*er is .----% The $ae of a *no$n hih(4#a"ity $or*er $h is 3---% The $ae for a*no$n "o$(4#a"ity $or*er $" is 3----%

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