Free-Response Review Questions

  1. Question

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    Identify whether each of the following situations reflects moral hazard or adverse selection. Propose a potential solution to reduce the inefficiency that each situation creates.

    Rubric for FRQ 1 (8 points)

    1 point: Adverse selection

    1 point: Sellers could offer a warranty with the car that pays for repair costs.

    1 point: Moral hazard

    1 point: Each insured person can be made to pay a co-payment of a certain dollar amount each time he or she gets a filling.

    1 point: Moral hazard

    1 point: Pay the workers “piece rates,” that is, pay them according to how much they have produced each day.

    1 point: Adverse selection

    1 point: Provide potential employers with references from previous employers.

  2. Question

    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

Discussion Starters

  1. Question

    In what situations have you experienced asymmetric information? What screening or signaling was involved?

  2. Question

    Do you experience moral hazard by taking fewer precautions when the cost of damage would be at least partially someone else’s problem? For example, this might be the case when a product is under warranty, a car or home is being rented, or insurance would cover the cost of damage.

  3. Question

    Describe a case in which you used a seller’s reputation to deal with asymmetric information.