Chapter 19/The Economics of Information 177
Chapter 19: Practice Quiz
The Economics of Information
1. An individual is willing to pay something for information because
a. information is costly.
b. it is always better to know than not to know.
c. this allows him or her to increase utility.
d. information is a public good.
2. An individual will not choose to acquire all available information because selective acquiring of information would
a. maximize utility given his or her budget constraint.
b. violate the assumption of risk aversion.
c. take advantage of the increasing returns to additional information.
d. recognize the decreasing marginal costs of acquiring information.
3. According to the usual economic story, adverse selection arises in insurance markets because
a. insurance buyers have more information than insurance sellers.
b. insurance sellers have more information than insurance buyers.
c. individuals can select which insurance company to patronize.
d. insurance companies can exercise too much control over who they insure.
4. If insurance policies are hopelessly complex and insurance companies don’t have reputations based on the quality of service they provide, then, in addition to the issue discussed in the previous question, it might be the case that adverse selection arises in insurance markets because
a. insurance buyers have more information about policies than do insurance sellers.
b. insurance sellers have more information about policies than do insurance buyers.
c. collecting information on policy details and company service records is costless.
d. none of the above.
5. Adverse selection in competitive insurance markets harms
a. high risk individuals.
b. low risk individuals.
c. owners of insurance companies.
6. Which of the following illustrates adverse selection?
a. Individuals sometimes mistakenly buy defective cameras.
b. Individuals will not search for bargains for low cost items.
c. Individuals know a lot about their family health history when they buy insurance.
d. Individuals can choose whether to drive safely or not.
7. Suppose high risk individuals face a .25 probability of having a $20,000 car stolen whereas low risk individuals face a .10 probability. Each type of buyer is equally represented in the population and each is risk-neutral. If the insurance company cannot differentiate between buyers and there are no administrative costs, insurance will cost
a. $3,500.
b. $5,000.
c. $2,000.
d. $7,000.
8. Adverse selection can arise in employment situations if information about worker quality is
a. better for employees than employers.
b. better for employers than employees.
c. perfect.
d. available at a low enough cost.
Question 9 is based on a firm composed of 5 workers, each with a utility function of the form
where l is hours worked and w is the wage which is assumed to be $20 per hour.
9. If the firm can monitor the number of hours worked by each worker (and pay accordingly), how many hours will each worker choose to work?
a. 2 hours
b. 4 hours
c. 8 hours
d. 10 hours
10. A risk averse buyer of a new car believes there is a 50 percent chance she can save $1,000 if she travels out-of-state to buy the car. She will make the trip only if it costs
a. less than $1,000.
b. less than $500.
c. zero.
d. an amount that cannot be exactly determined from the information given.
11. A price searcher who adopts a “reservation price” strategy will choose that price which equates the marginal cost of search to
a. the expected gain from searching for a lower price.
b. the expected gain from checking one more source.
c. the expected gain from lowering this price slightly.
d. the expected gain from buying more of the good.
12. The stockholdermanager relationship is best described as a(n)
a. principal-agent relationship.
b. powerpowerless relationship.
c. agentprincipal relationship.
d. symbiotic relationship.
13. Unlike an owner, a manager may be more concerned with than with . Which pair of words best completes this sentence?
a. profits; benefits.
b. benefits; profits.
c. profits; working conditions.
d. cost; revenue.
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Chapter 20/Externalities and Public Goods 181
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