Markets with Private Information – Chapter 12 Test Bank – 9e

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Foundations of Microeconomics, 9e (Bade)

Chapter 12 Markets with Private Information

12.1 The Lemons Problem and its Solution

1) Private information is a situation in which

A) two parties to an exchange have information that is available to outsiders if they ask.

B) one party to an exchange has information that is not available to the other.

C) the marginal cost of a person's obtaining additional information is zero.

D) the marginal cost of making information available to one more person is zero.

E) outsiders have relevant information that is not available to the people in the market.

Topic: Private information

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

2) Of the following, the best example of private information is when

A) Michael knows the price of a gallon of milk at the minimart but Michelle doesn't know.

B) you are selling a used car and you know your used car's defects but a potential buyer cannot find out about them until after buying.

C) you are selling a used car and you do not know your used car's defects.

D) you don't know the quality of a used car and must hire a trained mechanic who tells you all its defects.

E) you pay the owner of a used car a little extra and she lets you know all of the car's defects.

Topic: Private information

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

3) Adverse selection is created by

A) incentives to change behavior after two parties have reached an agreement.

B) risk.

C) signaling.

D) taxes.

E) private information.

Topic: Adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

4) Adverse selection can occur when

A) all parties have full information.

B) one party has information not available to the other party.

C) information is not full but both parties have the same information.

D) incentives result in one party not reaching an agreement with the other party.

E) nobody has any information.

Topic: Adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

5) The tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party is known as

A) adverse selection.

B) a pooling selection.

C) moral hazard.

D) the market for oranges.

E) a signal.

Topic: Adverse selection

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

6) Adverse selection is the tendency for people who accept contracts to be those who

A) buy goods and then regret it later.

B) buy goods for more than their own reservation price.

C) want to avoid the lemons problem.

D) plan to use private information to the disadvantage of the less well-informed party.

E) engage in a number of searches larger than that specified in the contract.

Topic: Adverse selection

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

7) In the used car market, adverse selection is a problem primarily when

A) sellers cannot judge buyers' creditworthiness.

B) buyers cannot signal their willingness to buy.

C) buyers cannot determine the quality of a used car.

D) sellers offer warranties on all used cars.

E) sellers and buyers both agree that a particular used car is a lemon.

Topic: Lemons problem

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

8) The used car market without warranties suffers from

A) perfect competition.

B) a separating equilibrium.

C) oligopoly.

D) adverse selection.

E) excessive signaling.

Topic: Lemons problem

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Revised

AACSB: Reflective thinking

9) Without warranties, used car buyers can assume that all used cars are "lemons" because of

A) moral hazard.

B) false signals.

C) moral dilemma.

D) adverse selection.

E) adverse reaction.

Topic: Lemons problem

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

10) In the used car market without warranties, adverse selection results in

A) sellers of "lemons" claiming that their car is a lemon.

B) only lemons being available for sale.

C) the market price of used cars equal to that of good used cars.

D) an efficient pooling equilibrium.

E) all of the above.

Topic: Lemons problem

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

11) Suppose that there are only two types of used cars, peaches and lemons. Peaches are worth $10,000 and lemons are worth $4,000. Without effective signals such as warranties, the owners of peaches cannot sell their cars for $10,000 because the

A) owners of peaches cannot convince buyers that their cars are worth $10,000.

B) buyers cannot convince owners of peaches to sell their cars for $10,000.

C) owners of lemons cannot convince buyers that their cars are worth more than $4,000.

D) buyers cannot convince owners of lemons to sell their cars for more than $4,000.

E) buyers cannot convince owners of lemons to sell their cars for $4,000.

Topic: Market for used cars

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

12) Suppose that there are only two types of used cars, peaches and lemons. Peaches are worth $10,000, and lemons are worth $6,000. Three fourths of all used cars are peaches, and one fourth are lemons. In a market with no signals, for instance, a market without warranties, the average value of cars actually sold will be

A) $6,000.

B) $7,000.

C) $7,500.

D) $9,000.

E) $10,000.

Topic: Market for used cars

Skill: Level 4: Applying models

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

13) Suppose there are only two kinds of cars in the market for used cars: lemons and good cars. A lemon is worth $1,000 both to its current owner and to anyone who buys it. A good car is worth $8,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car, and there is no warranty. What is the equilibrium price of a used car?

A) $8,000

B) $1,000

C) $4,500

D) $9,000

E) The equilibrium price depends on how many lemons and how many good cars are traded.

Topic: Market for used cars

Skill: Level 4: Applying models

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

14) Signals are believable when the cost of sending a ________ is known to be ________.

A) false signal; low

B) false signal; high

C) true signal; low

D) true or false signal; low

E) true signal; high

Topic: Private information; signals

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

15) Your grade point average acts as ________ to potential employers.

A) a signal

B) private information

C) a reservation price

D) a guarantee

E) insurance

Topic: Private information; signals

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

16) One of the ways the market for used cars copes with the problems associated with private information is through the offering of

A) leases.

B) warranties.

C) low interest rates.

D) high prices for high-quality used cars.

E) low prices.

Topic: Market for used cars, warranties

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

17) Used car buyers believe a car is good quality when the seller signals the car's quality by offering a warranty because

A) car sellers would never lie.

B) car buyers are gullible.

C) signals lead to efficient pooling equilibriums.

D) the signal cannot be false.

E) a false signal can be costly to the seller.

Topic: Market for used cars, warranties

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

18) Used car buyers believe a car is good quality when the seller signals the car's quality by offering a warranty because

A) a warranty on a lemon is costly to the seller.

B) warranties are only offered on lemons.

C) the signal cannot be false.

D) adverse selection means that warranties will not be used as a signal.

E) a false signal has no effect on the seller.

Topic: Market for used cars, warranties

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

19) Warranties in the used car market ________ the problem of private information thereby causing the price of good and bad used cars to ________.

A) reduce; be the same

B) reduce; differ

C) magnify; be the same

D) magnify; differ

E) None of the above answers is correct because warranties have nothing to do with private information.

Topic: Market for used cars, warranties

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

20) In the used car market with no warranties, the equilibrium is a ________ and there is ________.

A) pooling equilibrium; inefficiency, partly because of oversupply of good cars

B) pooling equilibrium; inefficiency, partly because of oversupply of lemons

C) separating equilibrium; no inefficiency

D) separating equilibrium; inefficiency, partly because of oversupply of lemons

E) pooling equilibrium; no inefficiency

Topic: Market for used cars, inefficient

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

21) In the used car market with warranties, the market for lemons (poor quality used cars) is ________ and the market for good cars is ________.

A) efficient; efficient

B) inefficient because of oversupply; inefficient because of undersupply

C) inefficient because of oversupply; inefficient because of oversupply

D) efficient; inefficient because of undersupply

E) inefficient because of oversupply; efficient

Topic: Market for used cars, efficient

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

22) In the used car market with warranties, the equilibrium is a ________ and there is ________.

A) pooling equilibrium; inefficiency, partly because of oversupply of good cars

B) pooling equilibrium; inefficiency, partly because of oversupply of lemons (poor quality used cars)

C) separating equilibrium; no inefficiency

D) separating equilibrium; inefficiency, partly because of oversupply of lemons (poor quality used cars)

E) pooling equilibrium; no inefficiency

Topic: Market for used cars, efficient

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

23) In the used car market with warranties, the equilibrium is a ________ and the lemons problem is ________.

A) pooling equilibrium; solved

B) pooling equilibrium; unresolved

C) separating equilibrium; unresolved

D) separating equilibrium; solved

E) pooling equilibrium; possibly solved and possibly unresolved, depending on whether good used cars sell for a higher price than do lemons

Topic: Market for used cars, efficient

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

24) Asymmetric information means that

A) the buyer must have information that the seller does not have.

B) the seller must have information that the buyer does not have.

C) the buyer and seller have the same information.

D) either the buyer has information that the seller does not have or the seller has information that the buyer does not have.

E) None of the above answers is correct.

Topic: Private information

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

25) The fact that people who know they are risky drivers are more likely to buy auto insurance reflects

A) adverse selection.

B) moral hazard.

C) a separating equilibrium.

D) signaling.

E) the lemons problem.

Topic: Adverse selection

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

26) The lemons problem in the used car market is that

A) the price of a lemon is too high.

B) the price of a lemon is too low.

C) no lemons are bought and sold.

D) only lemons are bought and sold.

E) Both answers A and D are correct.

Topic: Lemons problem

Skill: Level 1: Definition

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

27) If buyers cannot assess the quality of used cars and there are no warranties

A) only lemons are sold.

B) only good used cars are sold.

C) good cars are sold at a higher price than bad cars.

D) there is no adverse selection problem.

E) lemons and good cars sell for the same price.

Topic: Lemons problem

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

28) JCPenney guarantees to refund a customer's money if the customer returns poorly made clothing. This guarantee is an example of

A) the adverse selection problem.

B) the moral hazard problem.

C) the cost of risk.

D) signaling.

E) a lemon problem.

Topic: Signals

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

29) In the used car market, with a pooling equilibrium the price of a lemon is ________ the price of a good used car and with a separating equilibrium the price of a lemon is ________ the price of a good used car.

A) less than; equal to

B) equal to; less than

C) equal to; more than

D) more than; more than

E) equal to; equal to

Topic: Market for used cars

Skill: Level 4: Applying models

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

30) CARFAX is a service that provides comprehensive vehicle history reports on accidents and maintenance for used cars. By providing this reliable information to used car buyers, CARFAX helps

A) solve the lemon problem.

B) create only adverse selection.

C) create only moral hazard.

D) create a pooling equilibrium.

E) create both adverse selection and moral hazard.

Topic: Market for used cars

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Analytical thinking

31) CARFAX is a service that provides comprehensive vehicle history reports on accidents and maintenance for used cars. By providing this reliable information to used car buyers, CARFAX helps ________ in the used car market.

A) create adverse selection

B) create a pooling equilibrium

C) create a separating equilibrium

D) drive down prices

E) create the need for warranties

Topic: Market for used cars

Skill: Level 5: Critical thinking

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

12.2 Information Problems in Insurance Markets

1) The idea of an insurance company "pooling" the risk means that

A) the risk is completely eliminated from society.

B) the insurance company requires buyers to pay a large deductible.

C) the risk is spread over a large population.

D) the insurance company insists on a pooling equilibrium.

E) moral hazard and adverse selection are eliminated.

Topic: Pooling risk

Skill: Level 1: Definition

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

2) In the auto insurance market, who is most likely to have private information that leads to adverse selection?

A) the government agency that regulates insurance companies

B) the insurance company

C) the drivers

D) the insurance company and the drivers

E) the government regulating agency and the insurance company

Topic: Private information

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

3) In the insurance market, private information

A) creates moral hazard but eliminates adverse selection.

B) creates adverse selection but eliminates moral hazard.

C) creates both moral hazard and adverse selection.

D) eliminates both moral hazard and adverse selection.

E) means that screening is unnecessary.

Topic: Private information

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

4) In the insurance market, moral hazard and adverse selection are the result of

A) poorly functioning markets.

B) government intervention.

C) private information.

D) treachery.

E) a separating equilibrium.

Topic: Private information

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

5) Moral hazard is

A) the tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party.

B) when one of the parties to an agreement has an incentive after the agreement is made to act in a manner that brings additional benefits to himself or herself at the expense of the other party.

C) a situation in which only bad quality items are bought and sold.

D) absent after a person who dislikes risk buys insurance against the risk.

E) an action taken outside a market that conveys information that can be used by that market.

Topic: Moral hazard

Skill: Level 1: Definition

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

6) In an insurance market, moral hazard exists chiefly because of

A) economies of scale.

B) adverse selection.

C) diseconomies of scale.

D) private information.

E) public information.

Topic: Moral hazard

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

7) Because Don has health insurance, he is more likely to see the doctor when he has a cold. This is an example of

A) adverse selection.

B) moral hazard.

C) the lemons problem.

D) both moral hazard and adverse selection.

E) private information.

Topic: Moral hazard

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

8) If Sally drives less carefully after buying auto insurance, she illustrates

A) adverse selection.

B) negative selection.

C) screening risk.

D) moral hazard.

E) lemon hazard.

Topic: Market for insurance; moral hazard

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

9) In the market for automobile insurance, moral hazard implies that

A) those who are insured might take greater risks.

B) those who are uninsured might take greater risks.

C) insured and uninsured alike will take greater risks.

D) screening will have no effect in the market.

E) drivers with greater risks are more likely to buy insurance.

Topic: Market for insurance; moral hazard

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

10) Dan, age 19, may have trouble buying auto insurance at a low price because insurance companies

A) have private information that he is a risky driver.

B) have private information that his signals are valid.

C) fear that he has private information that his deductible is too high.

D) fear that he has private information that he is a risky driver.

E) operate in markets in which screening is inefficient.

Topic: Market for health insurance; adverse selection

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

11) In the market for automobile insurance, adverse selection implies that

A) those who are insured might take greater risks.

B) those who are uninsured might take greater risks.

C) private information cannot be successfully screened.

D) insured and uninsured alike will take greater risks.

E) drivers with greater risks are more likely to buy insurance.

Topic: Market for insurance; adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

12) In the market for automobile insurance, adverse selection implies that

A) drivers with greater risks want to buy a policy without deductibles.

B) drivers with greater risks want to buy a policy with large deductibles.

C) uninsured drivers will drive recklessly.

D) insured drivers will drive recklessly.

E) moral hazard does not exist in this market.

Topic: Market for insurance; adverse selection

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

13) Life insurance companies often give applicants a physical examination to prevent

A) moral hazard.

B) screening.

C) adverse selection.

D) signaling.

E) warranties.

Topic: Market for insurance; adverse selection

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

14) Bill purchases property insurance for his office building, which includes coverage for fire damage. The policy offers premium discounts for smoke detectors, fire alarms, fire extinguishers and sprinkler systems. This is an incentive system to help avoid

A) adverse selection.

B) adverse signals.

C) moral hazard.

D) screening.

E) None of the above answers is correct.

Topic: Market for insurance; adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

15) "Screening" means that an auto insurance company is

A) enforcing a pooling equilibrium.

B) ignoring all private information.

C) creating an incentive to eliminate moral hazard even though it reinforces the possibility of adverse selection.

D) creating an incentive to eliminate adverse selection even though it reinforces the possibility of moral hazard.

E) creating an incentive for a risky driver to reveal that he or she is risky.

Topic: Market for insurance; screening

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

16) When an auto insurance company is screening, it is

A) ignoring the possibility of moral hazard in order to minimize adverse selection.

B) attempting to keep its private information private.

C) trying to determine if a driver is an aggressive driver or a safe driver.

D) making its private information public.

E) marketing its policies to customers.

Topic: Market for insurance; screening

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

17) Auto insurance companies charge a lower premium to drivers who carry a higher deductible because

A) insurance companies are not profit maximizers.

B) a driver's riskiness increases as the driver's deductible increases.

C) a high deductible signals a high risk.

D) insurance companies prefer that drivers carry no deductible.

E) a high deductible reveals that driver is a careful driver.

Topic: Market for insurance; screening

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

18) One way of screening in the automobile insurance market is for companies to

A) offer policies with different deductibles and different premiums.

B) insure only careful drivers.

C) insure only risky drivers.

D) eliminate policies with no-claim bonuses because these policies are usually not profitable.

E) offer warranties.

Topic: Market for insurance; screening

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

19) In the market for auto insurance, in a pooling equilibrium

A) risky and safe drivers pay the same premium for insurance.

B) risky drivers pay a larger premium than do safe drivers for insurance.

C) risky drivers pay a smaller premium than do safe drivers for insurance.

D) risky drivers cannot obtain insurance.

E) safe drivers cannot obtain insurance.

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

20) In the market for auto insurance, in a separating equilibrium

A) risky and safe drivers pay the same premium for insurance.

B) risky drivers pay a larger premium than do safe drivers for insurance.

C) risky drivers pay a smaller premium than do safe drivers for insurance.

D) risky drivers cannot obtain insurance.

E) safe drivers cannot obtain insurance.

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

21) In the market for auto insurance, with a pooling equilibrium ________ and with a separating equilibrium ________.

A) aggressive drivers pay a higher premium than do safer drivers; aggressive drivers pay a higher premium than do safer drivers

B) no one can buy auto insurance; aggressive drivers pay a higher premium than do safer drivers

C) aggressive and safe drivers pay the same premium; aggressive and safe drivers pay the same premium

D) aggressive and safe drivers pay the same premium; aggressive drivers pay a higher premium than do safer drivers

E) aggressive drivers pay a higher premium than do safer drivers; aggressive and safe drivers pay the same premium

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

22) A safe driver is likely to prefer an auto insurance policy that has a ________ deductible and a ________ premium.

A) high; high

B) high; low

C) low; high

D) low; low

E) None of the above answers is correct because private information has no effect in the market for auto insurance.

Topic: Market for insurance; screening

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

23) In the United States, of all types of insurance, people spend the most on ________ insurance.

A) health

B) hurricane

C) auto

D) life

E) property and casualty

Topic: Market for insurance

Skill: Level 1: Definition

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

24) Insurance companies

A) pool risk and enable everyone to share the costs of bad outcomes.

B) never can earn a profit because they accept risk.

C) eliminate the risk of a bad outcome.

D) know who will have a bad outcome.

E) are risk averse.

Topic: Market for insurance

Skill: Level 1: Definition

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

25) When Sam makes an agreement and then behaves after the agreement in a way to increase his benefits and harm then other party to the agreement, Sam is illustrating

A) moral hazard.

B) adverse selection.

C) signaling.

D) the cost of contracting.

E) a pooling equilibrium.

Topic: Market for insurance; moral hazard

Skill: Level 1: Definition

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

26) Ben is an aggressive driver so he is more likely to buy auto insurance. This situation illustrates the idea of

A) moral hazard.

B) adverse selection.

C) the lemon problem.

D) inefficiency.

E) a pooling equilibrium.

Topic: Market for insurance; adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

27) If you have private information that you are a riskier driver than your record indicates, you are likely to buy an insurance policy that has a ________ deductible and a ________ premium.

A) high; high

B) high; low

C) low; high

D) low; low

E) None of the above answers is correct because private information has no effect in the market for auto insurance.

Topic: Market for insurance; screening

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

28) Screening

A) leads to a pooling equilibrium in the insurance market.

B) means an uninformed person passes knowledge to an informed person.

C) makes no-claim bonuses unnecessary.

D) explains why insurance companies offer low-premium, high-deductible policies and high-premium, low-deductible policies.

E) makes the insurance market inefficient.

Topic: Market for insurance; screening

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

29) Progressive Auto Insurance offers applicants the chance to temporarily install its Snapshot device to monitor their driving habits prior to signing up for insurance. This device

A) allows screening to occur.

B) creates adverse selection.

C) drives auto insurance premiums higher for all drivers.

D) drives auto insurance deductible rates higher for all drivers.

E) creates a pooling equilibrium.

Topic: Market for insurance; screening

Skill: Level 5: Critical thinking

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

30) Progressive Auto Insurance offers applicants the chance to temporarily install its Snapshot device to monitor their driving habits prior to signing up for insurance. This practice will result in

A) a pooling equilibrium

B) a separating equilibrium.

C) lower deductibles for safe drivers.

D) low premiums for unsafe drivers.

E) equal premiums for all drivers.

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 5: Critical thinking

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

31) The figure shows the market for auto insurance. Progressive Auto Insurance offers applicants to temporarily install its Snapshot device to monitor their driving habits prior to signing up for insurance. This practice should result in ________ paying a premium of ________ per year.

A) 120 million safe drivers; $500

B) 100 million drivers; $500

C) 120 million safe drivers; $700

D) 80 million unsafe drivers; $500

E) 80 million unsafe drivers; $700

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Application of knowledge

32) The figure shows the market for auto insurance. Progressive Auto Insurance offers applicants to temporarily install its Snapshot device to monitor driving habits prior to signing up for insurance. This practice should result in ________ paying a premium of ________ per year.

A) 100 million safe drivers; $900

B) 120 million safe drivers; $700

C) 80 million unsafe drivers; $900

D) 80 million safe drivers; $500

E) 100 million drivers; $700

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Application of knowledge

33) The figure shows the market for auto insurance. Progressive Auto Insurance offers applicants to temporarily install its Snapshot device to monitor driving habits prior to signing up for insurance. Which of the following statements are TRUE as a result of this practice?

i. Safe drivers will pay a $500 premium and a high deductible.

ii. Unsafe drivers will pay a $900 premium and a low deductible.

iii. A pooling equilibrium will occur.

A) i and iii

B) ii and iii

C) i only

D) ii only

E) i and ii only

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Application of knowledge

34) The figure shows the market for car insurance. If the companies can't determine who is a safe or an unsafe driver, ________ drivers are insured at a premium of ________.

A) only safe drivers; $1,000

B) only safe drivers: $800

C) only 100 unsafe drivers; $800

D) 150 safe and unsafe; $1,000

E) 150 unsafe; $1,000

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Application of knowledge

35) The figure shows the market for car insurance. If the companies can't determine who is a safe or unsafe driver, a ________ equilibrium occurs and the premium is ________ per year.

A) pooling; $1,000

B) pooling; $800

C) pooling; between $800 and $1,000

D) separating; $1,000

E) separating; $800

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Application of knowledge

12.3 Health-Care Markets

1) In the health insurance market, adverse selection occurs when

A) chronically ill people buy health insurance.

B) insured people go to the doctor unnecessarily.

C) patients sue their doctor.

D) people with health insurance tend to behave more recklessly.

E) chronically ill people are unable to buy health insurance.

Topic: Market for health insurance; adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

2) If a health insurance company offers coverage regardless of age, health status, or smoking history, it is likely to suffer

A) moral hazard problems.

B) adverse selection problems.

C) lower costs.

D) low demand for its product.

E) a screening equilibrium.

Topic: Market for health insurance; adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

3) In the health insurance market, moral hazard occurs when

A) chronically ill people buy insurance.

B) chronically ill people cannot buy insurance.

C) providers overtreat patients.

D) patients sue their doctor.

E) chronically ill people refuse appropriate medical treatment.

Topic: Market for health insurance; moral hazard

Skill: Level 1: Definition

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

4) In the market for health care services, Health Maintenance Organizations

A) exist to insure people with pre-existing medical conditions.

B) overprovide medical care and thereby result in increased costs.

C) help overcome adverse selection by enrolling only healthy clients.

D) help overcome moral hazard by monitoring the quality of the service.

E) None of the above answers is correct.

Topic: Market for health care; moral hazard

Skill: Level 1: Definition

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

5) Which of the following statements about health-care systems is correct?

A) Most major nations do not have extensive government-funded insurance programs.

B) U.S. expenditure per person on health care is near the middle of the range of expenditures made in major nations.

C) Unlike other major nations, private health insurance is not available only in the United States.

D) In the United States, Medicare and Medicaid account for slightly less than 90 percent of total expenditures on health care.

E) In the United States, most healthcare services are provided by private doctors and hospitals.

Topic: Health-care systems

Skill: Level 1: Definition

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

6) Health-care vouchers have been proposed. These vouchers would

A) cap total expenditure on health care but do nothing to solve the problem of uninsurance.

B) limit choice and would create long waiting times for health care service.

C) solve the problem of the doctor shortage but would not affect the problem of over spending on health care.

D) ensure universal coverage for health care and would cap total expenditure on health care.

E) None of the above answers is correct.

Topic: Health-care systems

Skill: Level 1: Definition

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

7) Which of the following is not a problem in health-care markets?

A) Hospitals are not trying to maximize their profit.

B) asymmetric information

C) underestimation of future needs

D) adverse selection

E) None of the above answers is correct; that is, all the answers are problems in health-care markets.

Topic: Health-care markets

Skill: Level 2: Using definitions

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

8) Moral hazard in the market for health-care services leads

A) patients to adopt healthy life styles.

B) to a separating equilibrium.

C) to all people buying health insurance.

D) to healthy people not buying health insurance.

E) to providers overtreating patients.

Topic: Health-care markets

Skill: Level 2: Using definitions

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

9) Compared to other major nations, the United States spends ________ on health care and achieves ________ efficiency.

A) less; greater

B) more; about the same

C) less; less

D) more; less

E) about the same; less

Topic: Health-care systems

Skill: Level 1: Definition

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

10) Tim exercises everyday and eats healthy. Cam is a couch potato and smokes. A health insurance company can't tell the difference between Tim and Cam's behavior. As a result, ________ occurs and the health insurance company is likely to offer a policy with ________.

A) asymmetric information; low premiums and high deductibles

B) asymmetric information; high deductibles and low premiums

C) a separating equilibrium; low premiums and high deductibles

D) a deadweight loss; high deductibles and low premiums

E) the lemons problem; low premiums and high deductibles

Topic: Health-care markets

Skill: Level 5: Critical thinking

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

11) Tim exercises everyday and eats healthy. Cam is a couch potato and smokes. A health insurance company can't tell the difference between Tim and Cam's behavior. As a result, Tim will be offered a policy with a ________ and Cam will be offered a policy with a ________.

A) low deductible; low premium

B) high deductible; low deductible

C) high deductible; high deductible

D) low deductible; low deductible

E) low deductible; high premium

Topic: Health-care markets

Skill: Level 5: Critical thinking

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

12) Obamacare ________ in the health insurance market ________.

A) creates moral hazard; but an efficient outcome occurs

B) creates adverse selection; but an efficient outcome occurs

C) creates a pooling equilibrium; and generates an efficient outcome

D) creates a separating equilibrium; and an inefficient outcome occurs

E) may create efficiency; but more information is needed about the amount of the subsidies

Topic: Obamacare

Skill: Level 5: Critical thinking

Section: Checkpoint 12.3

Status: Old

AACSB: Application of knowledge

12.4 Chapter Figures

The figures show two auto insurance markets, one market for safe drivers and one market for aggressive drivers.

1) The market for aggressive drivers is illustrated in ________, and the market for safe drivers is illustrated in ________.

A) Figure A; Figure A also

B) Figure B; Figure A

C) Figure A; Figure B

D) Figure B; Figure B also

E) More information is needed to answer the question.

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

2) In a pooling equilibrium, aggressive drivers pay a premium of ________ and safe drivers pay a premium of ________.

A) $1,000; $1,000

B) $800; $1,200

C) $1,200; $800

D) $1,000; $800

E) $1,200; $1,000

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Analytical thinking

3) In a separating equilibrium, aggressive drivers pay a premium of ________ and safe drivers pay a premium of ________.

A) $1,000; $1,000

B) $800; $1,200

C) $1,200; $800

D) $1,000; $800

E) $1,200; $1,000

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Analytical thinking

4) In a pooling equilibrium, there ________ a deadweight loss in the market for safe drivers, and there ________ a deadweight loss in the market for aggressive drivers.

A) is; is

B) is; is not

C) is not; is

D) is not; is not

E) might be; might be

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Analytical thinking

5) In a pooling equilibrium, there is ________ of insurance in the market for safe drivers, and there is ________ of insurance in the market for aggressive drivers.

A) overprovision; underprovision

B) overprovision; overprovision

C) underprovision; underprovision

D) underprovision; overprovision

E) underprovision; an efficient quantity

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Analytical thinking

6) In a separating equilibrium, there is ________ of insurance in the market for safe drivers, and there is ________ of insurance in the market for aggressive drivers.

A) overprovision; underprovision

B) overprovision; overprovision

C) underprovision; underprovision

D) underprovision; overprovision

E) an efficient quantity; an efficient quantity

Topic: Market for insurance; pooling and separating equilibriums

Skill: Level 4: Applying models

Section: Checkpoint 12.2

Status: Old

AACSB: Analytical thinking

7) The figures show the expenditures per person on health care and the efficiency of the health care system in 8 different nations. The United States is best represented by bar ________ in expenditures per person and is bar ________ in efficiency index.

A) A; A

B) B; A

C) A; D

D) E; E

E) D; B

Topic: Health-care systems

Skill: Level 1: Definition

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

12.5 Integrative Questions

1) Moral hazard typically occurs because

A) people are dishonest.

B) agreements sometimes create incentives that are costly to monitor so people can act in their self-interest.

C) workers possess diminishing marginal productivity.

D) screening leads to informed people revealing their relevant private information.

E) workers possess adverse selection.

Topic: Moral hazard

Skill: Level 1: Definition

Section: Integrative

Status: Old

AACSB: Reflective thinking

2) Moral hazard results from ________ information, and adverse selection results from ________ information.

A) private; private

B) private; public

C) public; private

D) public; public

E) None of the above answers is correct because both are the result of the lemons problem.

Topic: Private information

Skill: Level 1: Definition

Section: Integrative

Status: Old

AACSB: Reflective thinking

3) If a salesperson is paid by the volume of sales he or she makes, then the

A) moral hazard problem is diminished.

B) lemons problem can be screened.

C) moral hazard problem is enhanced.

D) adverse selection problem is enhanced.

E) None of the above answers is correct.

Topic: Moral hazard and adverse selection

Skill: Level 3: Using models

Section: Integrative

Status: Old

AACSB: Reflective thinking

4) Which of the following is an example of moral hazard?

A) I hire you to work in my garden for a fixed fee, and you work hard all day.

B) I hire you to work at an hourly rate and you work as slowly as possible.

C) You apply for the job only because I pay a fixed wage per day, no matter how much or little you do.

D) You agree to be paid by the weed to work in my garden, and then you work hard.

E) You agree to be paid by the weed to work in my garden, and then you don't work hard.

Topic: Moral hazard

Skill: Level 3: Using models

Section: Integrative

Status: Old

AACSB: Reflective thinking

5) The lemons problem is caused by

A) health-care providers' incentive to order unnecessary tests.

B) used car buyers' inability to determine the quantity of used cars offered for sale.

C) auto insurance companies inability to adequately screen drivers.

D) the missing health care market.

E) government regulations than make some information private.

Topic: Lemons problem

Skill: Level 2: Using definitions

Section: Integrative

Status: Old

AACSB: Reflective thinking

6) In the used car market, adverse selection creates the lemon problem when

A) sellers cannot judge buyers' creditworthiness.

B) buyers believe that sellers will offer only high-priced "good" used cars for sale.

C) buyers believe that sellers will sell only lemons.

D) sellers offer warranties on all used cars.

E) None of the above answers is correct because it is moral hazard that creates the lemon problem.

Topic: Lemons problem

Skill: Level 1: Definition

Section: Integrative

Status: Old

AACSB: Reflective thinking

7) In the used car market, ________ is (are) a way of signaling.

A) high-deductibles

B) warranties

C) low interest rates

D) high prices for high-quality used cars

E) screening, using low prices for low quality used cars and high prices for high quality used cars

Topic: Signals

Skill: Level 2: Using definitions

Section: Integrative

Status: Old

AACSB: Reflective thinking

8) ________ occurs when an informed person takes an action to send information to an uninformed person, and ________ occurs when an uninformed person creates an incentive for an informed person to reveal private information.

A) Moral hazard; adverse selection

B) Adverse selection; moral hazard

C) Signaling; screening

D) Screening; signaling

E) Pooling; separating

Topic: Signals

Skill: Level 1: Definition

Section: Integrative

Status: Old

AACSB: Reflective thinking

9) Private information

A) can create adverse selection but plays no role in creating moral hazard.

B) explains why drivers screen auto insurance companies.

C) means that unless it is overcome, the equilibrium in the market will be a separating equilibrium.

D) plays a role in the markets for health-care insurance and auto insurance.

E) cannot explain why the U.S. expenditures on health care per person exceed those in other major nations.

Topic: Private information

Skill: Level 2: Using definitions

Section: Integrative

Status: Old

AACSB: Reflective thinking

10) Even if your college degree is irrelevant to an employer's needs, your high GPA might still get you the job because

A) the firm is not a profit maximizer.

B) your GPA screens some of your private information.

C) your GPA sends a signal about your quality as a worker.

D) the firm will most likely make an adverse selection.

E) the high GPA eliminates the possibility of moral hazard.

Topic: Private information; signals

Skill: Level 3: Using models

Section: Integrative

Status: Old

AACSB: Reflective thinking

11) Which of the following can create inefficiency and deadweight loss?

A) Moral hazard can create inefficiency and deadweight loss but adverse selection cannot.

B) Adverse selection can create inefficiency and deadweight loss but moral hazard cannot.

C) Both moral hazard and adverse selection can create inefficiency and deadweight loss.

D) Neither moral hazard nor adverse selection can create inefficiency and deadweight loss.

E) None of the above answers is correct because whether inefficiency and deadweight loss are created depends on whether the moral hazard and adverse selection affect demanders or suppliers.

Topic: Private information

Skill: Level 2: Using definitions

Section: Integrative

Status: Old

AACSB: Reflective thinking

12) In the market for used cars, the lemons problem means that owners of ________ cars have no incentive to offer them for sale because the market price is ________ than their marginal benefit.

A) good; more

B) bad; more

C) bad; less

D) fair; more

E) good; less

Topic: Private information

Skill: Level 5: Critical thinking

Section: Integrative

Status: Old

AACSB: Reflective thinking

13) In the market for automobile insurance, drivers can reveal that they are low risk by buying policies with ________ deductibles and ________ premiums.

A) high; low

B) low; high

C) high; high

D) low; low

E) zero; high

Topic: Private information

Skill: Level 5: Critical thinking

Section: Integrative

Status: Old

AACSB: Analytical thinking

14) The private market ________ health care because it sometimes ________ those with pre-existing conditions and because people ________ the benefits of health care.

A) underprovides; includes; overestimate

B) underprovides; excludes; underestimate

C) overprovides; includes; overestimate

D) overprovides; excludes; underestimate

E) underprovides; includes; underestimate

Topic: Health-care markets

Skill: Level 5: Critical thinking

Section: Integrative

Status: Old

AACSB: Analytical thinking

12.6 Essay: The Lemons Problem and its Solution

1) Explain the concept of adverse selection. Give an example.

Topic: Adverse selection

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

2) Consider a market for used cars. Suppose there are only two kinds of cars: lemons and good cars. A lemon is worth $1,500 both to its current owner and to anyone who buys it. A good car is worth $6,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car. What do economists call the problem that buyers of used cars face? What kind of cars (lemons, good cars, or both) are traded? Explain and substantiate your answer.

Topic: Used car market

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

3) Consider a market for used cars. Suppose there are only two kinds of cars: lemons and good cars. A lemon is worth $1,500 both to its current owner and to anyone who buys it. A good car is worth $6,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car. What do economists call the problem that buyers of used cars face? What is the price of a used car? Explain and substantiate your answer.

Topic: Used car market

Skill: Level 3: Using models

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

4) How can a warranty at the seller's expense signal that a product is high quality?

Topic: Private information; signals

Skill: Level 2: Using definitions

Section: Checkpoint 12.1

Status: Old

AACSB: Reflective thinking

12.7 Essay: Information Problems in Insurance Markets

1) What is private information and what problems does it create?

Topic: Private information

Skill: Level 1: Definition

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

2) Explain the concept of moral hazard. Give an example.

Topic: Moral hazard

Skill: Level 1: Definition

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

3) "People buy insurance to protect themselves from moral hazard." True or false? Explain.

Topic: Moral hazard

Skill: Level 2: Using definitions

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

4) Most college professors are granted tenure after six years of employment. Tenure implies a lifetime appointment. What problem does this situation create, and how can colleges minimize the problem?

Topic: Moral hazard

Skill: Level 3: Using models

Section: Checkpoint 12.2

Status: Old

AACSB: Reflective thinking

12.8 Essay: Health-Care Markets

1) What is the private information in the market for health-care insurance? What is the private information in the market for health care?

The private information in the market for health care is the information possessed by sellers of health care services. In particular, sellers of health-care services (for instance, doctors, hospitals, etc.) know if they are high-quality/low-cost providers, who diagnose and treat reliably, or if they are low-quality/high-cost providers, who are prone to costly errors.

Topic: Private information

Skill: Level 2: Using definitions

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking

2) What role does moral hazard play in the market for health care?

Topic: Private information

Skill: Level 3: Using models

Section: Checkpoint 12.3

Status: Old

AACSB: Reflective thinking