Principles of Economics, 7th Edition (MindTap Course List)
7th Edition
ISBN: 9781285165875
Author: N. Gregory Mankiw
Publisher: Cengage Learning
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Chapter 22, Problem 2QR
To determine
The problem of adverse selection.
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Briefly explain what is “signaling” (from an economist’s view) and how it may reduce adverse selection.
What is moral hazard?
Consider the model of the market for lemons from Chapter 22. Suppose that there are two types of used cars — good ones and lemons — and that sellers know which type of car they have. Buyers do not know which type of car a seller has. The fraction of used cars of each type is 21 and buyers know this. Let’s suppose that a seller who has a good car values it at $10,000 and a seller with a lemon values the lemon at $5,000. A seller is willing to sell his car for any price greater than or equal to his value for the car; the seller is not willing to sell the car at a price below the value of the car. Buyers’ values for good cars and lemons are $14,000 and $8,000, respectively. As in Chapter 22 we will assume that buyers are risk-neutral; that is, they are willing to pay their expected value of a car.
(a) Is there an equilibrium in the used-car market in which all types of cars are sold? Briefly explain.(b) Is there an equilibrium in the used-car market in which only lemons are sold? Briefly…
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Principles of Economics, 7th Edition (MindTap Course List)
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- The idea that ethical judgments are universal was advanced by: a. Kant & Hare b. Dostoyevsky & Kant c. Bentham & Dostoyevsky d. Dostoyevsky & Harearrow_forwardgive an example of an existing economic interaction that exhibits moral hazard. describe the setting and talk about efficiency considerations.arrow_forwardThere is a telling joke about two economists walking down the street. They spot a $20 bill on the sidewalk. One stoops to pick it up, but the other one says, “Don’t bother; if the bill was real, someone would have picked it up already.” The lesson is clear. A strong belief in efficient markets can disable the investor and make it appear that no research effort can be justified. Do you think there are still enough anomalies in the empirical evidence to justify the search for overpriced/underpricedsecurities? Support your answer with examples and new theories in the context of Efficient Market Hypothesis.arrow_forward
- There are two types of people in the economy: low and high risk. Each earns $100. When they are healthy they get to consume the full $100. When they are ill they have to pay $100 of medical costs and have O left for consumption The government is has heard about adverse selection and is considering offering a single insurance plan and making everyone buy it. Using the information in the table below determine what plan the government will offer. The government's insurance plan will require people to pay a premium (tax) of $ when healthy and will give them a benefit of $ when ill. Low Risk High Risk Utility U = Vc U = Vc Percent of Population 70% 30% Risk of illness 10% 50%arrow_forwardIn the automobile insurance market, adverse selection occurs when Group of answer choices A) drivers with greater risks buy a policy with large deductibles. B) drivers with greater risks buy a policy with no deductibles. C) uninsured drivers drive recklessly. D) insured drivers drive recklessly.arrow_forwardAn insurance company is looking to provide a full coverage health insurance plan to the 10 professors in the economics department at the University of Alabama. Seven of these professors are in great health and will incur no medical expenses this year. Six professors have chronic conditions which require $5000 of medical care per year for each professor. a. If the insurance company is looking to insure the entire group, what will be the actuarially fair premium it charges? b. If professors have the option to enroll in the insurance plan, what will be the profit to the insurance company if it charges the premium in part (a)? c. Name the economic phenomenon occurring in this example.arrow_forward
- Consider two people called Young and Old. Young and Old live together. Young can choose to party or not to party. Young values going to party at $10. The cost of the risk of getting Corona from going to the party is $1 for Young. However, the cost to Old of getting Corona from Young if he goes to the party is $20. a. Suppose there is no bargaining and that Young doesn't care about Old. What is Young's privately optimal action, Party or No Party? b. Given the answer to (a), does this maximize social surplus (Net Payoff of Young + Net Payoff of Old)? c. Suppose Young has a right to party (Old cannot forcibly prevent Young). Old and Young bargain over Young going to party. How much will Old have to offer Young to make him willing to not party?arrow_forwardOne method of solving this problem is through signaling. Signaling is a strategy one uses when they have information. The goal is to use a signal to convince the buyer that the good or service that is being sold is quality and will meet the buyer's wants. Offer an example of a company that uses a signal to help sell its product. What is the signal? What information is the signal trying to convey? Do you think the signal is effective? Why or why not? Does this signal improve market efficiency? Why or why not?arrow_forwardWhat is Moral Hazard, and how does moral hazard affect the likelihood a population demands medical care and the total demand for medical care?arrow_forward
- What are moral hazard and adverse selection? How are they similar, how are they different? What causes each?arrow_forwardHow does the implementation of behavioral economics principles influence the success of fundraising campaigns for non-profit organizations?arrow_forwardThe principal of a school hires Daniel to teach eighth grade students. One goal the principal has is to prepare the students to do well on standardized tests, as he will be judged based on the results of those tests. Daniel prefers to teach in a more creative way, so the students learn a lot, but perform poorly on their standardized tests. This is an example of what problem? a. Adverse hazard b. Moral hazard c. Adverse selection d. Free-ridingarrow_forward
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