A people are more likely to lock their own car than a

This preview shows page 76 - 79 out of 92 pages.

a. People are more likely to lock their own car than a rental car.
75 b. Skateboarders attempt more difficult maneuvers when wearing a helmet. c. Bad salespeople are less drawn to commission-based jobs. d. People with fire insurance are less likely to install smoke alarms. 7. Which of the following is true? a. Moral hazard is primarily an issue prior to a transaction. b. Adverse selection is primarily an issue after a transaction. c. Moral hazard is the result of an information asymmetry. d. Resolving adverse selection also resolves moral hazard. 8. Restrictive covenants on loans are used to avoid a. moral hazard. b. adverse selection. c. free riding. d. None of the above 9. Loan applications require a lot of information from applicants to avoid a. moral hazard. b. adverse selection. c. free riding. d. None of the above 10. Which of the following is true about moral hazard? a. Moral hazard arises from actions that cannot be observed. b. Shirking is a form of moral hazard. c. Moral hazard refers to the taking of excessive risk. d. All of the above Multiple Choice Key 1. D 2. D 3. D 4. C 5. D 6. C 7. C 8. A 9. B 10. D Short Answer Questions 20-1 Extended Warranties Your product fails about 2% of the time, on average. Some customers purchase the extended warranty you offer in which you will replace the product if it fails. Would you want to price the extended warranty at 2% of the product price? Discuss both moral hazard and adverse selection issues.
76 20-2 Business Loan A colleague tells you that he can get a business loan from the bank, but the rates seem very high for what your colleague considers a low risk loan. a. Give an adverse selection explanation for this, and offer advice to your friend on how to solve the problem. b. Give a moral hazard explanation for this, and offer advice to your friend on how to solve the problem. 20-3 Locator Beacons for Lost Hikers Lightweight personal locator beacons are now available to hikers that make it easier for the Forest Service s rescue teams to locate those lost or in trouble in the wilderness. How will this affect the costs that the Forest Service incurs? 20-4 Auto Insurance Suppose that every driver faces a 1% probability of an automobile accident every year. An accident will, on average, cost each driver $10,000. Suppose there are two types of individuals: those with $60,000 in the bank and those with $5,000 in the bank. Assume that individuals with $5,000 in the bank declarebankruptcy if they get in an accident. In bankruptcy,creditors receive only what individualshave in the bank. What is the actuarially fairprice of insurance? What price are individualswith $5,000 in the bank willing to pay for theinsurance? Will those with $5,000 in the bankvoluntarily purchase insurance? What is the effectof state laws forcing individuals to purchaseauto liability insurance?

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture