Multiple Choice Questions
1. Which of the following is an example of moral hazard?
a. Reckless drivers are the ones most likely to buy automobile insurance.
b. Retail stores located in high-crime areas tend to buy theft insurance more often than stores located in low-crime areas.
c. Drivers who have many accidents prefer to buy cars with air bags.
d. Employees recently covered by the company health plan start going to the doctor every time they get a cold.

2. In a bad economy, a CEO has a 4% chance of meeting earnings estimates at regular effort, and a 5% at extraordinary effort.
Extraordinary effort costs the CEO $10,000 in extra effort. How a large of a bonus should the CEO be paid for meeting estimates to encourage extraordinary effort?
a. $100,000
b. $200,000
c. $250,000
d. $1,000,000

3. A salesperson can put in regular effort (resulting in a 40% chance of sale) or high effort (60% chance of sale). If high effort costs the salesperson $20 more than regular effort, how large of a per-sale bonus is required to encourage high effort?
a. $12
b. $20
c. $33.33
d. $100

4. Which of the following is not an example of a process designed to combat moral hazard problems?
a. Banks include restrictive covenants in loan agreements.
b. Universities have students complete evaluations of professor performance at the end of a class.
c. Insurance companies require applicants to provide medical history information as part of the application process.
d. Employers regularly monitor employee performance.

5. Which of the following is an example of moral hazard?
a. High-quality products being driven out of a market by low quality products.
b. A local charity raising insufficient funds because no one contributes, expecting that their neighbors will.
c. A bakery defaults on its loan because of a new consumer fear of carbohydrates.
d. A corporation uses a business loan secured for one investment on another, higher-risk investment.

6. Which of the following is not an example of moral hazard?
a. People are more likely to lock their own car than a rental car.
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