Exam 17: Uncertainty and Asymmetric Information

You are in the market for a used 2016 Toyota Corolla. You know that half of the 2016 Corollas are lemons and half are peaches. If you could be assured that the Corolla you were buying was a peach, you would be willing to pay up to $12,000. On the other hand, you would only be willing to pay $4,000 for a lemon. You have no ability to discern whether any particular Corolla is a lemon or a peach. Sellers of Corollas, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $3,000 or more and peach sellers will be willing to sell their cars for $9,000 or more. If you are risk neutral, you are willing to offer ________ and ________ are willing to sell you their car.

Consider the following game. You roll a six-sided die and each time you roll a 1, you get $50. For all other outcomes you pay $10. Since the expected value of this game is $0, the game is called a(n)

Refer to the data provided in Table 17.3 below to answer the following question(s). The table shows the relationship between income and utility for Terri. Table 17.3 Income Total Utility \ 0 0 \ 20,000 10 \ 40,000 25 \ 60,000 45 \ 80,000 75 -Refer to Table 17.3. From the table, we can see that Terri is

Annie, a high school student, babysits to earn extra cash. In order to differentiate herself from other babysitters, Annie took a babysitting course from the Red Cross. This is an example of a market signal.

A credit union faces a(n) ________ problem when it lends funds to a customer to remodel her home and the customer then opportunistically uses the funds for a gambling trip to Las Vegas.

Refer to the data provided in Table 17.6 below to answer the following question(s). The table shows the relationship between income and utility for Isabel. Table 17.6 Income Total Utility \ 0 0 \ 40,000 20 \ 80,000 50 \ 120,000 90 \ 160,000 150 -Refer to Table 17.6. Suppose Isabel has a 25% chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Isabel does not become disabled, she will earn her usual salary of $160,000. Isabel has the opportunity to purchase disability insurance for $40,000 which will pay her her full salary in the event she becomes disabled. Isabel's utility with the policy is

Buyers and sellers use ________ to communicate the quality of goods and services in a world of uncertainty.

Adverse selection and moral hazard are problems that arise in the presence of asymmetric information.

An area of economics that explores how contract or transaction structures can overcome asymmetric information problems is

Refer to the data provided in Table 17.1 below to answer the following question(s). The table shows the relationship between income and utility for Jane. Table 17.1 Income Total Utility \ 0 0 \ 20,000 25 \ 40,000 45 \ 60,000 60 \ 80,000 70 -Refer to Table 17.1. Suppose Jane has a 1/3 chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Jane does not become disabled, she will earn her usual salary of $60,000. Jane has the opportunity to purchase disability insurance which will pay her her full salary in the event she becomes disabled. On average, how much would such a contract cost the insurance company (per person)?

As a result of adverse selection problems in the health insurance market, it is likely that over time

An automobile finance company faces an adverse selection problem if borrowers

________ arises when one party to a contract changes behavior in response to that contract, passing the cost of that change in behavior to the other party.

Moral hazard occurs when one party to a contract changes his behavior in response to that contract and thus passes on costs of that behavior to the other party.

For a given individual, as their income decreases, their utility from that income

You own a car dealership and pay all of your sales people a flat salary. As a result, they don't work very hard to generate sales. This is an example of

If ________ enters into an exchange with another party who has ________ information, there is asymmetric information and adverse selection.

Moral hazard occurs when buyers and sellers take actions to communicate quality in a world of uncertainty.

Moral hazard can do harm to one party to a contract, but always results in efficient behavior.

Relating to the Economics in Practice on page 362: The smart phone app which allows skiers at a slope to report weather conditions to others would lessen the problem of