Chapter 22 Mankiw/Taylor, Economics

Name:

True/False
Indicate whether the sentence or statement is true or false.

Asymmetric information is a problem that occurs when one person in a transaction knows more about what is going on than the other.

In the principal agent relationship, the principal performs a task on behalf of the agent.

Employers may pay higher than equilibrium wages to avoid moral hazard in the employment relationship by raising the cost of shirking.

To avoid the problem of adverse selection, insurance companies screen their prospective customers to discover hidden health problems.

Signals to convey high quality are most effective when they are costless to all firms in the industry.

If A is preferred to B, B preferred to C, and A is preferred to C, then these preferences exhibit the property of unanimity.

The Condorcet paradox shows that majority-rule voting always tells us the outcome that society really wants.

Arrow's impossibility theorem shows that no voting system can satisfy the properties required of a perfect voting system.

According to the median voter theorem, majority rule will produce the average preferred outcome.

10.

Politicians do not always choose the ideal economic policy because some politicians are corrupt and greedy, and others are willing to sacrifice the national interest for local popularity.

11.

In the real world, people always behave rationally when making economic decisions.

12.

The ultimatum game demonstrates that people will always make choices according to their self-interest.

13.

Since people tend to care about fairness, firms may give bonuses during particularly profitable years to be fair and to avoid retaliation from the workers.

14.

People seem to naturally engage in delayed gratification and they tend to follow through on plans made today to do something unpleasant in the future.

15.

Since people are reluctant to change their minds in the face of new information, we can conclude that people do not always behave as rational maximizers.

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

16.

John's car is in need of repair so John decides to sell it to avoid the repair bill. Unaware of the problem, Suzanne buys the car. This is an example of

a.	hidden actions.
b.	adverse selection.
c.	efficiency wages.
d.	moral hazard.

17.

Nicole wants to avoid buying a car that is a lemon. She takes a car she would like to buy to her mechanic before she purchases it. This is known as

a.	screening.
b.	signalling.
c.	moral hazard.
d.	adverse selection.

18.

Markus is a travelling salesman for an apparel company. In this employment relationship, Markus is the

a.	agent.
b.	principle.
c.	screener.
d.	signaller.

19.

Which of the following must be true about a signal that is used to reveal private information in order for the signal to be effective?

a.	It must be "as seen on TV."
b.	It must be free to the signalling party.
c.	It must be costly to the signalling party but less costly to the party with the higher-quality product.
d.	It must be applied to an inexpensive product.

20.

Which of the following is an example of a signal that is used to reveal private information?

a.	Enzo carefully chooses a special gift for Josephine.
b.	Josephine earns her MBA from the Harvard Business School.
c.	Lexus advertises its cars during the football World Cup Final.
d.	All of these answers are correct.

21.

Which of the following is not a method firms use to avoid the moral hazard problem in the employment relationship?

a.	They pay employees with delayed compensation such as a year-end bonus
b.	They buy life insurance on their workers
c.	They pay above equilibrium wages
d.	They put hidden video cameras in the workplace

22.

Which of the following best demonstrates the problem of moral hazard?

a.	Josephine doesn't buy health insurance because it is too expensive and she is healthy.
b.	A life insurance company forces Enzo to have a medical examination prior to selling him insurance.
c.	Enzo drives more recklessly after he buys car insurance.
d.	Fatima chooses to attend a well-respected college.

23.

A life insurance company forces Enzo to have a medical examination prior to selling him insurance.

a.	transitivity.
b.	impossibility.
c.	independence.
d.	unanimity.

24.

Refer to Figure 22-1. What percent of the population votes for A when the choice is between A and B?

a.	75 percent
b.	35 percent
c.	60 percent
d.	40 percent
e.	25 percent

25.

Refer to Figure 22-1. Under pairwise majority voting, which outcome wins?

a.	C
b.	These preferences suffer from the Condorcet paradox so there is no clear winner.
c.	B
d.	A

26.

Refer to Figure 22-1. If we first compare A to C, and then compare the winner to B, which outcome is the winner?

a.	A
b.	C
c.	B
d.	These preferences suffer from the Condorcet paradox so there is no clear winner.

27.

Refer to Figure 22-1. Using a Borda count, which outcome is preferred?

a.	C
b.	B
c.	A
d.	These preferences do not exhibit transitivity so there is no clear winner.

28.

Which of the following is not a property required of a perfect voting system?

a.	the median voter always wins
b.	no dictators
c.	independence of irrelevant alternatives
d.	transitivity

29.

Suppose that 40 percent of the voting population wish to spend €1,000 for artwork in City Hall, 25 percent wish to spend €20,000, and 35 percent wish to spend €22,000. What is the median preferred outcome, the average preferred outcome, and the modal preferred outcome?

a.	€20,000; €20,000; €22,000
b.	€1,000; €14,333; €1,000
c.	€20,000; €13,100; €1,000
d.	€1,000; €20,000; €22,000

30.

Which of the following is true under pairwise majority rule if people vote for the outcome closest to their most preferred outcome?

a.	The average preferred outcome wins.
b.	There is no clear winner due to Arrow's Impossibility Theorem.
c.	The outcome preferred by the median voter wins.
d.	The outcome preferred by the greatest number of voters wins.

31.

Which of the following is not true about how people make decisions?

a.	People give too much weight to a small number of vivid observations.
b.	People are sometimes too sure of their own abilities.
c.	All of these answers are actually true statements about how people make decisions.
d.	People are always rational maximizers.
e.	People are reluctant to change their minds in the face of new information.

32.

In the ultimatum game, what split would be rational for both the person proposing the split and the person who must accept or reject the split?

a.	There is no rational solution.
b.	75/25
c.	99/1
d.	1/99
e.	50/50

33.

Which of the following help explain why firms pay bonuses to workers during particularly profitable years to prevent workers from becoming disgruntled?

a.	People are rational maximizers.
b.	People are reluctant to change their minds.
c.	People are inconsistent over time.
d.	People care about fairness.

34.

John's friend dies of a sudden heart attack. John rushes to his doctor for an expensive physical examination. This response demonstrates that

a.	people give too much weight to a small number of vivid observations.
b.	people easily change their minds when confronted with new information.
c.	people enjoy going to the doctor.
d.	people tend to plan ahead and follow through on their plans.

35.

Which of the following is a response to people's inconsistent behaviour over time?

a.	all of these answers
b.	forced contributions to a retirement plan
c.	year end bonuses
d.	efficiency wages