Because there is an imbalance of information in a lending situation, we must deal with the problems of adverse selection and moral hazard. Define these terms and explain how financial intermediaries can reduce these problems
What will be an ideal response?
Adverse selection is the asymmetric information problem that exists before the transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit risk. Moral hazard is the asymmetric information problem that exists after the transaction occurs. For lenders, it is the difficulty in making sure the borrower uses the funds appropriately. Financial intermediaries can reduce adverse selection through intensive screening and can reduce moral hazard by monitoring the borrower.
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Bobby's neighbor is growing a tree that is blocking Bobby's ocean view. Bobby is considering taking his neighbor to court. To Bobby, the tree represents a(n)
a. unclear property right b. public good c. free-rider good d. positive externality e. negative externality
An economist would be more likely to argue for reducing inflation if she thought that
a. the central bank lacked credibility and if bonds were usually not indexed for inflation. b. the central bank lacked credibility and if bonds were usually indexed for inflation. c. the central bank had credibility and if bonds were usually not indexed for inflation. d. the central bank had credibility and if bonds were usually indexed for inflation.
Which statement best describes a capitalist economy?
a. Government policies determine the production and the allocation of goods and services b. The role of individual self-interest is relatively unimportant because government makes most of the economic decisions c. Government policies determine the production, but not the allocation, of goods and services d. Society determines production and the allocation of goods and services only through markets
Which of the following distinguishes a natural monopoly from monopoly caused by ownership of a vital resource?
A. The natural monopoly has a marginal cost curve above its average cost curve at all levels of output, whereas the marginal cost in other monopolies is above average cost. B. The natural monopoly does not require any government intervention because it is only efficient to have one large firm supplying the market, but other monopolies do require government intervention to maintain efficiency. C. The natural monopoly has a downward-sloping long-run average cost curve as opposed to a U-shaped long-run average cost curve. D. The natural monopoly occurs with naturally occurring products like gold and diamonds, whereas other monopolies occur with man-made products.