Explain why the following reactions might reflect some deviation from rationality. a

What is moral hazard? List three things an employer might do to reduce the severity of this problem.

What is adverse selection? Give an example of a market in which adverse selection might be a problem.

Define signaling and screening and give an example of each.

What unusual property of voting did Condorcet notice?

Explain why majority rule respects the preferences of the median voter rather than the average voter.

Describe the ultimatum game. What outcome from this game would conventional economic theory predict? Do experiments confirm this prediction? Explain.

Each of the following situations involves moral hazard. In each case, identify the principal and the agent, and explain why there is asymmetric information. How does the action described reduce the problem of moral hazard? a. Landlords require tenants to pay security deposits. b. Firms compensate top executives with options to buy company stock at a given price in the future. c. Car insurance companies offer discounts to customers who install antitheft devices in their cars

Suppose that the Live-Long-and-Prosper Health Insurance Company charges $5,000 annually for a family insurance policy. The companys president suggests that the company raise the annual price to $6,000 to increase its profits. If the firm followed this suggestion, what economic problem might arise? Would the firms pool of customers tend to become more or less healthy on average? Would the companys profits necessarily increase?

A case study in this chapter describes how a boyfriend can signal to a girlfriend that he loves her by giving an appropriate gift. Do you think saying I love you can also serve as a signal? Why or why not?

Some AIDS activists believe that health insurance companies should not be allowed to ask applicants if they are infected with the HIV virus that causes AIDS. Would this rule help or hurt those who are HIV-positive? Would it help or hurt those who are not HIV-positive? Would it exacerbate or mitigate the problem of adverse selection in the market for health insurance? Do you think it would increase or decrease the number of people without health insurance? In your opinion, would this be a good policy? Explain your answers to each question.

The government is considering two ways to help the needy: giving them cash or giving them free meals at soup kitchens. Give an argument for giving cash. Give an argument, based on asymmetric information, for why the soup kitchen may be better than the cash handout.

Ken walks into an ice-cream parlor. Waiter: We have vanilla and chocolate today. Ken: Ill take vanilla. Waiter: I almost forgot. We also have strawberry. Ken: In that case, Ill take chocolate. What standard property of decision making is Ken violating? (Hint: Reread the section on Arrows impossibility theorem.)

Three friends are choosing a restaurant for dinner. Here are their preferences: a. If the three friends use a Borda count to make their decision, where do they go to eat? b. On their way to their chosen restaurant, they see that the Mexican and French restaurants are closed, so they use a Borda count again to decide between the remaining two restaurants. Where do they decide to go now? c. How do your answers to parts (a) and (b) relate to Arrows impossibility theorem?

Three friends are choosing a TV show to watch. Here are their preferences: a. If the three friends try using a Borda count to make their choice, what would happen? b. Monica suggests a vote by majority rule. She proposes that first they choose between Dexter and Glee, and then they choose between the winner of the first vote and House. If they all vote their preferences honestly, what outcome would occur? c. Should Chandler agree to Monicas suggestion? What voting system would he prefer? d. Phoebe and Monica convince Chandler to go along with Monicas proposal. In round one, Chandler dishonestly says he prefers Glee over Dexter. Why might he do this?

Five roommates are planning to spend the weekend in their dorm room watching movies, and they are debating how many movies to watch. Here is their willingness to pay: Buying a DVD costs $15, which the roommates split equally, so each pays $3 per movie. a. What is the efficient number of movies to watch (that is, the number that maximizes total surplus)? b. From the standpoint of each roommate, what is the preferred number of movies? c. What is the preference of the median roommate? d. If the roommates held a vote on the efficient outcome versus the median voters preference, how would each person vote? Which outcome would get a majority? e. If one of the roommates proposed a different number of movies, could his proposal beat the winner from part (d) in a vote? f. Can majority rule be counted on to reach efficient outcomes in the provision of public goods?

A group of athletes are competing in a multiday triathlon. They have a running race on day one, a swimming race on day two, and a biking race on day three. You know the order in which the eligible contestants finish each of the three components. From this information, you are asked to rank them in the overall competition. You are given the following conditions: The ordering of athletes should be transitive: If athlete A is ranked above athlete B, and athlete B is ranked above athlete C, then athlete A must rank above athlete C. If athlete A beats athlete B in all three races, athlete A should rank higher than athlete B. The rank ordering of any two athletes should not depend on whether a third athlete drops out of the competition just before the final ranking. According to Arrows impossibility theorem, there are only three ways to rank the athletes that satisfy these properties. What are they? Are these desirable? Why or why not? Can you think of a better ranking scheme? Which of the three properties above does your scheme not satisfy?

Two ice-cream stands are deciding where to set up along a 1-mile beach. The people are uniformly located along the beach, and each person sitting on the beach buys exactly 1 icecream cone per day from the nearest stand. Each ice-cream seller wants the maximum number of customers. Where along the beach will the two stands locate? Of which result in this chapter does this outcome remind you?

Explain why the following reactions might reflect some deviation from rationality. a. After a widely reported earthquake in California, many people call their insurance company to apply for earthquake insurance. b. In January, many fitness clubs offer special annual membership fees to attract customers who have made New Years resolutions to exercise more. Even when these memberships are costly, many of these new customers seldom visit the gym to work out.