Chapter 16 — Quiz

Multiple choice

Q1. Adverse selection occurs: a) After a contract is signed b) Before a transaction, when the composition of participants is skewed by asymmetric information c) Only in healthcare markets d) When prices are too high

Q2. Moral hazard occurs: a) Before a transaction b) After a contract is signed, when one party changes behavior in ways the other can't fully observe c) Only in insurance markets d) When information is symmetric

Q3. Akerlof's "lemons" model shows that: a) Used cars are always bad b) When buyers can't observe quality, good sellers withdraw and the market can spiral to low quality c) All markets work efficiently d) Lemons are underpriced

Q4. Signaling involves: a) The uninformed party testing the informed party b) The informed party taking a costly credible action to reveal their type c) The government providing information d) Random assignment

Q5. A college degree can function as a signal because: a) It teaches useful skills b) It's costly to obtain, so only high-ability people find it worthwhile, which separates high from low ability c) Employers require it by law d) It's free

Q6. Screening involves: a) The informed party revealing information voluntarily b) The uninformed party designing a menu that induces self-selection c) The government requiring disclosure d) Random sampling

Q7. An insurance company offering both high-deductible and low-deductible plans is an example of: a) Signaling b) Screening c) Moral hazard d) Market equilibrium

Q8. eBay's seller rating system is an example of: a) Government regulation b) A reputation system that reduces adverse selection c) Price discrimination d) A public good

Q9. In the 2008 financial crisis, mortgage originators lent carelessly because: a) They planned to hold the loans for 30 years b) They planned to sell the loans to investors and didn't bear the long-term risk (moral hazard) c) The government required them to lend d) Interest rates were too high

Q10. AIG's credit default swap crisis illustrates: a) Good risk management b) Moral hazard — AIG collected premiums for insuring risk it didn't understand or adequately reserve for c) Adverse selection only d) Efficient insurance markets

Q11. Credit rating agencies in the 2008 crisis: a) Correctly assessed the risk of mortgage-backed securities b) Had conflicts of interest (paid by issuers) that contributed to information failure c) Were not involved d) Performed perfectly

Q12. The distinction between adverse selection and moral hazard is: a) Adverse selection is about hidden information before the transaction; moral hazard is about hidden action after b) They are the same thing c) Adverse selection only affects insurance; moral hazard only affects labor d) Adverse selection always causes market collapse; moral hazard never does

Short answer

SA1. Walk through Akerlof's lemons model in three sentences.

SA2. Give one example each of signaling, screening, and a reputation system.

SA3. How did moral hazard at the mortgage origination level contribute to the 2008 crisis?

SA4. Why are reputation systems effective for repeat transactions but not for one-shot transactions?

SA5. Distinguish adverse selection from moral hazard using a health insurance example.

True / False

TF1. Adverse selection is a problem that occurs after a contract is signed. (True / False)

TF2. A warranty on a used car is a form of signaling. (True / False)

TF3. Reputation systems can be gamed with fake reviews. (True / False)

TF4. The 2008 crisis was primarily a moral hazard and adverse selection event. (True / False)

TF5. A college degree signals ability only if it also teaches useful skills. (True / False)

Selected answers in appendices/answers-to-selected.md.