ECO 301 TEST BANK FOR CHAPTER 15 Asymmetric Information

ECO 301 TEST BANK FOR CHAPTER
15 Asymmetric Information
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ECO 301 TEST BANK FOR CHAPTER 15 Asymmetric Information
1. The principal is distinct from the agent in the principal-agent model because
2. Which of the following is an application of the adverse selection problem?
3. Adverse selection arises in insurance markets because
4. Adverse selection in competitive insurance markets harms
5. An example of adverse selection is
6. Which of the following is an application of the moral hazard problem?
7. A risk-averse manager is hired to run a firm for shareholders. If the manager’s effort can be
observed and specified in a contract, which would be the best employment contract?
8. A risk-averse manager is hired to run a firm for shareholders. If shareholders cannot observe the
manager’s effort, which would be the best employment contract?
9. Given a series of employment contracts with the same slope (where slope refers to how the
contract varies with changes in the firm’s gross profits) but different intercepts (referring to the overall
generosity of the contract). Which of these is not a consideration in figuring out which of these intercepts the
shareholders would decide to build into the contract offered to the manager?
10. Which are social costs associated with the inability of shareholders to observe a manager’s effort?
(You may choose more than one.)
11. A monopoly coffee shop is deciding on a menu of different cup sizes to sell to a population of
consumers, some of whom are high demanders and some low demanders. How would the optimal menu differ
depending on whether the consumers can be observably separated into the different types or not?
12. How is it logically possible for a monopolist to get different consumers to purchase different bundles
on a menu (such as different sizes of coffee cups), and thereby achieve a form of price discrimination, even if
the firm cannot observe the consumers’ valuations directly?
13. How can a monopolist get different consumers to purchase different bundles on a menu (such as
different sizes of coffee cups), and thereby achieve a form of price discrimination, even if the firm cannot
observe the consumers’ valuations directly?
14. Which is a distortion (a loss of social surplus) associated with a monopolist’s inability to observe
consumer types when constructing a nonlinear pricing scheme?
15. Which of the following are potential problems faced by a firm that wants to provide warranties for its
lawnmowers? (Select all that apply.)
16. Concerning auctions, what is the definition of a “common-values setting”?
17. Which auction format generates the most revenue for the seller?
18. Suppose that your personal valuation for a painting is $200. Which auction format would induce you
to bid more?
19. How do participants in an auction respond to the problem of the “winner’s curse”?
20. In the Spence education signaling model, what is the social value of education?
21. One way the “lemons problem” in the used-car market can be mitigated is by
22. The “lemons model” predicts quality deterioration in the used car market because
23. A market characterized by asymmetric information will have an equilibrium price if at that price

24. A ready-to-eat cereal manufacturer faces two types of consumers, adults and children, having the
following schedule of gross surpluses for each additional unit of cereal consumed.
25. Return to the ready-to-eat cereal example from the previous question. Now assume that there is
only one kind of cereal, so the manufacturer cannot distinguish between types of consumer (adults vs. children,
of which suppose there are equal numbers in the market). What is the optimal menu of cereal boxes?
26. A manager can either slack (effort e = 0) or work hard (e = 1) on behalf of shareholders. If she
slacks, the firm earns a gross return of 1,000 for sure. If she works hard, there is an even chance of the gross
return being 10,000 or 80,000. Her overall utility equals her utility from wage income (of the form w 1/2 ,
wherew is the wage) minus the disutility of work (simply d), or in other words U = w 1/2 – d. If she slacks, she
experiences no disutility of work (d = 0) but if she works hard, the disutility of work is d = 50. Assume that U =
0 in her next best available job. What is the optimal wage contract that shareholders would offer if they can
observe the effort of the manager?
27. Return to the situation with the manager from the previous question. Now assume that shareholders
cannot observe effort, so cannot specify how hard the manager works in the contract but must induce it through
the incentive scheme. Which of the following wage contracts would work out best for shareholders in
equilibrium?
28. There are two types of worker, high ability and low ability. High ability workers generate gross profit
of A on the job and low ability generate nothing. Education does not make workers more productive, but is
costly to obtain (c H for high ability workers and c L for low ability ones). Let w be the wage that all firms in the
economy pay by regulatory mandate. Suppose the worker obtains utility given by the wage (if the worker is
employed, 0 if not) minus the cost of education (if any). There is no disutility from work. Which condition is
required if only the high ability type is to obtain an education in equilibrium?
29. Return to the case of education and the job market from the previous question. Which condition
would be consistent with both types’ obtaining an education in equilibrium?