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    Microeconomics - Problem Set 4

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    Juho Viljanen
    I. Asymmetric information is a problem that arises when parties in a transaction have different information and private incentives not to share it, such as sellers knowing more about product quality than buyers. II. Hidden attributes and hidden actions are forms of asymmetric information that can cause market failures like adverse selection and moral hazard in employment, insurance, and lending. III. Possible solutions include public information sharing, repeated interactions to build trust, and contractual arrangements with incentives or penalties to mitigate problems from asymmetric information.

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    Microeconomics - Problem Set 4

    Uploaded by

    Juho Viljanen
    48 views4 pages
    I. Asymmetric information is a problem that arises when parties in a transaction have different information and private incentives not to share it, such as sellers knowing more about product quality than buyers. II. Hidden attributes and hidden actions are forms of asymmetric information that can cause market failures like adverse selection and moral hazard in employment, insurance, and lending. III. Possible solutions include public information sharing, repeated interactions to build trust, and contractual arrangements with incentives or penalties to mitigate problems from asymmetric information.

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    Introduction to microeconomics problem set

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    I. Asymmetric information is a problem that arises when parties in a transaction have different information and private incentives not to share it, such as sellers knowing more about product quality than buyers. II. Hidden attributes and hidden actions are forms of asymmetric information that can cause market failures like adverse selection and moral hazard in employment, insurance, and lending. III. Possible solutions include public information sharing, repeated interactions to build trust, and contractual arrangements with incentives or penalties to mitigate problems from asymmetric information.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    48 views4 pages

    Microeconomics - Problem Set 4

    Uploaded by

    Juho Viljanen
    I. Asymmetric information is a problem that arises when parties in a transaction have different information and private incentives not to share it, such as sellers knowing more about product quality than buyers. II. Hidden attributes and hidden actions are forms of asymmetric information that can cause market failures like adverse selection and moral hazard in employment, insurance, and lending. III. Possible solutions include public information sharing, repeated interactions to build trust, and contractual arrangements with incentives or penalties to mitigate problems from asymmetric information.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 4

    1.

    Which of the statements below are true:


    I. A contract is incomplete when information is unavailable or unverifiable.
    II. Asymmetric information is a problem in the interaction between two parties of a
    transaction when their objective functions differ. This means that the informed party has no
    incentive to share information with the uninformed one.
    a) I only
    b) II only
    c) I and II
    d) Neither

    2. Which of the statements below are true:


    I. An employer-worker relationship suffers from a form of asymmetric information
    problem known as hidden attributes.
    II. A firm’s recruiter faces a hidden action problem because candidates have more
    information about their own qualifications and past experience than the recruiter and have an
    incentive to conceal negative signals.
    a) I only
    b) II only
    c) I and II
    d) Neither

    3. Which of the following is NOT a reason why there is a hidden attributes / an


    adverse selection problem in the market for used cars?
    a) The seller has more information about the quality of a particular car than the
    buyer does.
    b) The minimum acceptable price for a seller under full information is higher than
    the willingness to pay of the buyer for a given car.
    c) The average value of a car is the most a perspective buyer is willing to pay and
    this drives sellers of high-quality cars out of the market.
    d) Quality verification before a sale takes place is impossible / too costly for the
    buyer.
    4. Imagine there are ten cars on the market, valued at 0, 5000, 10000 … 45000
    Euros. Sellers are willing to sell as long as they receive strictly more than half of the true value
    of the car, while buyers are willing to buy as long as they pay at most the true car value. Which
    of the following statements is true?
    a) The average value of a car on this market is 25000 Euros and this is the price
    potential buyers are willing to pay for a car in this market under asymmetric information.
    b) Under asymmetric information, sellers whose car is valued at 25000 Euros or
    more will drop out of the market immediately.
    c) It is Pareto efficient to sell all cars because the value the buyers assign to a
    particular vehicle (willingness to pay) is higher than the value assigned by the seller (minimum
    acceptable price).
    d) If the buyers observed the true car value, all mutually beneficial trades would
    occur and the price would equal the willingness to pay of the buyer.

    5. Now consider the same ten cars on the market. Assume that sellers are willing to
    sell as long as they receive strictly more than half of the true value of the car (as before) but
    buyers are willing to buy as long they pay at most 1.5 times the value of the car. Which of these
    statements are true for the case of asymmetric information?
    I. Buyers in this market are willing to pay 33750 Euros.
    II. The willingness to pay of buyers for a car with an average quality is higher than
    the minimum acceptable price of the seller of the highest quality car on the market so there is no
    adverse selection problem.
    a) I only
    b) II only
    c) I and II
    d) Neither

    6. Consider a health insurance market with 100 potential buyers where 90 of them
    are healthy (90% chance of making no claim and 10% chance of making a claim of 10K) and 10
    of them are sick (50% chance of making no claim and 50% chance of making a claim of 20K).
    What is the expected claim in this population?
    a) 1.4K
    b) 1.6K
    c) 1.9K
    d) 2.1K

    7. Now consider the same health insurance market. Imagine that all potential buyers
    are risk averse and willing to pay 1K premium on top of their expected claim. What is the
    expected loss or profit for the insurer if he prices the product at 1.5K? And what about 1.9K?
    a) Loss of 50K; Break even
    b) Loss of 40K; Break even
    c) Break even; Profit of 20K
    d) Profit of 10K; Profit of 40K

    8. In which of those markets there is NO asymmetric information problem?


    a) dating / marriage market
    b) the market for dental insurance
    c) university admission
    d) FX trading

    9. Which is NOT a possible remedy for a hidden attributes problem?


    a) face-to-face negotiation and bargaining
    b) public information sharing
    c) repeated interaction and long-term contractual arrangements
    d) reliance on expert opinion

    10. Which of the following is NOT an attempt to mitigate a hidden attributes problem
    in a particular market?
    a) a credit registry
    b) seller ratings on Ebay
    c) an employment contract with a trial period clause
    d) incentive pay

    11. In a borrower-lender relationship there is an ex-ante moral hazard problem when


    the borrower has no incentive to put effort into the project because in the event of default it is the
    lender who bears the cost. On the other hand, an ex-post moral hazard problem is when a
    borrower has a successful project but still has no incentives to repay the loan.
    Which of the following statements are NOT true?
    a) A collateral can help mitigate both an ex-ante and an ex-post moral hazard
    problem and there are no equity concerns in requiring such for a loan.
    b) A loan with a very high interest rate exacerbates both an ex-ante and an ex-post
    moral hazard problem as reduces incentives for the borrower to put an effort into the project and
    to repay the loan conditional on success.
    c) Both types of moral hazard problem could lead to a market failure.
    d) Group lending can mitigate the moral hazard problem in lending by making
    borrowers jointly liable for their loans. This creates incentives for group members to help each
    other which increases the probability of success of a project (mitigates ex-ante moral hazard) and
    the personal relationship to other group members creates social pressure to repay the loan
    conditional on success (mitigates ex-post moral hazard).

    12. Which of the following is NOT an example of a merit good, which is commonly
    provided free of charge in most modern societies?
    a) legal representation
    b) housing for children
    c) basic healthcare
    d) college education

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