l. Recognizing the existence of asymmetric information Complete the foiiowing tabie by determining which economic problem is characterized in each of the scenarios provided, Adverse Moral Scenario Selection Hazard Clancy would like to buy a used plasma television, but he is not an electronics expert and, thus, cannot assess the quality of a TV directly before owning it. Clancy believes that owners of the worst TVs are more willing to sell their TVs than owners of the best TVs. Because of this, Clancyr believes that used TVs up for sale are probanyr of low 0 quality. When Becky didn't have renter's insurance, she was very careful not to leave candles lit in her apartment and locked the door when she left. Now that she has renter's insurance, she typically leaves candles burning all day and forgets to lock the door because she knows that, even if her apartment catches on fire or gets broken into, her insurance will 0 cover it. 2. The market for lemons Consider a market in which there are many potential buyers and sellers of used cars. Each potential seller has one car, which is either of high quality (a plum) or low quality (a lemon). A seller with a lowquality car is willing to sell it for $5,000, whereas a seller with a highquality car is willing to sell it for $9,500. A buyer is willing to pay $6,000 for a low quality car and $11,500 For a highquality car. 01' course, only the seller knows whether a car is of high or low quality, as illustrated in the accompanying image: Suppose that 80% of sellers have lowquality cars. Assume buyers know that 80% of sellers have low-quality cars but are unable to determine the quality of individual cars. If all sellers offer their cars for sale and buyers have no way of determining whether a car is a highquality plum or a lowquality lemon, the expected value of a car to a buyer is $?,100 (Hint: The expected value of a car is the sum of the probability of getting a lowquality car multiplied by the value of a lowquality car and the probability of getting a highquality car multiplied by the value of a highquality car.) Suppose buyers are willing to pay only up to the expected value ofa car that you found in the previous question. Suppose buyers are willing to pay onlyl up to the expected value of a car that you found in the previous question. Since sellers of lowquality cars are willing to sell for $5,000, while sellers of highquality cars are willing to sell for $9,500, onlI low-Quality: sellers V will be willing to participate in this market at that price. The dilemma in this problem is an example of which of the following economic concepts? '3) Moral hazard O Signalling 0 Screening 0 Adverse selection 3. How asymmetric information prevents gains from trade Ginny sees a classied ad from Eric offering a used car seat for $30. On the opposite page, she sees a big colour ad from a national retail chain offering a new car seat for $250. Ginny values a car seat at $300 as long as it works, regardless of whether it is new or used. For each of the scenarios listed, determine the principle illustrated by each person 's reasoning. Moral Adverse Scenario Hazard Selection Suppose Eric, the seller of the car seat, knows the seat is safehe is only selling it because his child has outgrown it. He thinks about asking $45 and offering a guarantee: He Will replace the car seat with a new $250 car seat if it turns 0 out not to work. Then he thinks "That's not a good idea! Someone can just buy it, handle it carelessly, and, if it breaks, can pretend it didn't work and get a new car seat for $45meanwhile, I'll be out $205!" Suppose Ginny buys the new car seat from the national retail chain, thinking "Someone would ask $30 for a used car 0 seat only if it didn't work well." Why is Eric unable to sell Ginny the car seat? Check all that apply. Moral hazard can prevent sellers from offering guarantees of quality because they can't be sure that buyers won't try to take advantage of the guarantees by ling false claims. C] Adverse selection can cause buyers to avoid purchasing highquality goods because of the uncertainty about their quality. 4. Asymmetric information and labour markets Lorenzo is the manager of a factory. Workers at the factory are assigned to one of two tasks, one of which requires skilled labour and one of which requires unskilled labour. Because skilled workers earn a higher wage than unskilled workers, everyone who applies for a job says they're skilled. Lorenzo's challenge is to figure out who is actually a skilled worker and who is an unskilled worker. Suppose that Lorenzo would like to use the economic concept of screening to separate out worker types. Which of the following scenarios illustrates this concept? 0 Skilled workers pay to take a certification course to demonstrate their ability. Lorenzo implements a test to determine whether applicants are skilled or not. 0 Lorenzo yoluntarily pays all workers a higher wage in hopes of attracting and retaining more productive workers. Suppose, instead, the manager considers paying efficiency wages to increase the factory's profitability. True or False: Efficiency wages are set equal to the average industry wage and are intended to weed out workers who are only interested in money. 0 True False 5. Understanding the Condorcet paradox Raphael, Susan, and BeckyI want to bake a cake. They are choosing among chocolate cake ('3), vanilla cake (I), and red velvet cake (E). The following table shows each person's preferences for cake flavours. The three friends decide to vote on the kind of cake they want and agree to bake the kind that wins by majority vote. Susan Becky First choice Second choice Third choice Suppose Raphael, Susan, and Becky rst vote on whether to bake a chocolate cake or a vanilla cake, and then theyr vote between red velvet cake and the Winner from the previous vote. Between chocolate cake and vanilla cake, the majority will vote for vanilla cake V , and between this winner and red velvet cake, the majority' will vote for chocolate cake V . Now, suppose Raphael, Susan, and Buecl-(yr rst vote on whether to bake a vanilla cake or a red velvet cake, and then they vote between chocolate cake and the winner from this vote. Between vanilla cake and red velvet cake, the majority will vote for red velvet cake 7 , and between this winner and chocolate cake, the majority will vote for chocolate cake V . True or False: Raphael, Susan, and Becky's democratic voting system does not produce transitive preferences. (Hint: Recall your answers to the previous questions.) True 0 False 6. Identifying the median voter Gilbelto, Lorenzo, and Sam are roommates who are trying to decide how much money each should contribute to a party they are throwing I Lorenzo would ideally contribute 525 because he only wants to buy pizza. However, he would prefer contributing SSS to contributing $0 and not having a party at all. I Gilberto wants to buy a $90 keg of beer and $75 worth of pizza. Therefore, he would ideally like each to contribute $55 to the palty, but if the others are unWIlling to contribute that much, he would settle for buying just the pizza (and contributing $25 each) and asking guests to bring beer. I Sam does not care about the party and is on a tight budget. Therefore, he prefers to contribute no money to the party, and his utility is constantly declining as they increase the amount of money they spend. Suppose the three roommates vote on spending either $0, $25, or $55 on the party using the Borda count system of voting. That is, each roommate awards three points to his first choice, two points to his second choice, and one point to his third choice. Complete the foiiowing tabie by indicating the number of points each roommate awards to each option and then summing the scores of each option to obtain a i'inai ranking. Borda Count For Spending... $55 $25 $0 Gilberto Lorenzo Sam Tntal Under a system of Borda count, the winning option is V If, instead, the roommates were to hold a twophase election (such that they first voted between two options, then voted between the winner of that contest and the finai option), the winner would be V . (Hint: Determine the outcome if the roommates first voted between $55 and $0, and then voted between the winner of that contest and $25.} The median voter in this situation is V . 7. Understanding Arrow's impossibility theorem Arrow's impossibility theorem states that under certain assumptions about preferences, no voting system exists which satisfies all of the following properties: 0 Unanimity - Transitivityur 0 Independence of irrelevant alternatives 0 No dictators Assume indiViduals in a society have preferences regarding the following possible outcomes: A, B, and C. For each description in the following table, identify the property of a desirable voting system it portrays. Independence of Irrelevant No Description Unanimity Tran5It Alternatives Dictators If everyone prefers C to A, then C beats A. O O O C) If A beats C, and C beats B, then A beats B. O O O Q There is no person who always gets what he wants, despite O O O O everyone else's preferences The ranking between C and A does not depend on whether B _ _ O O O O is also available. Consider the following voting system: In the plurality voting system, individuals vote only for their favourite candidate, and the candidate with the most votes wins. This may result in the winner having less than 50% of the vote. Consider the 1992 U.S. presidential election. Clinton won the election with about 43% of the popular vote, while George H.W. Bush had about 38%, and Ross Perot had about 19%. Suppose that if Perot didn't run, all Perot voters would have picked Bush. Then, Bush would have won the election with 57% of the vote. Which property does this voting method violate according to Arrow's impossibility theorem? 0 No dictators O Transitivity 0 Independence of irrelevant alternatives 0 Unanimity 8. Median voter outcome Consider the race for councillor of a small city. The population of the City is evenly divided between three city wardsSummertownI Elmswood, and Springfield. The councillor's race is between Ralph Rubin (the counCIllor of Summertown) and Tom Toolman (the councillor of Elmswood}. Assume that no matter what is said during the campaign, Rubin can count on the support of 100% of the Summertown population, and Toolman can count on the support of 100% of the Elniswood population. Assume 100% voter participation. According to the result of majority rule votingr the next councillor Will be the one preferred by the majority of the residents of V . The two candidates are asked in a debate about their support of recreational subsidies. Public opinion polls in Springfield have shown the following about the level of recreational subsidies desired: - 65% want a low level - 20% want a medium level - 15% want a high level With linear preferences, the median voter model predicts that the candidates will support a V level of recreational subsidies. 9. Behavioural economics Indicate whether each of the following examples of behaviour is consistent with the way the traditional economic framework suggests people should act, or if it is reserved for behavioural economists to examine. Reserved for Consistent with the Predictions Behavioural Example of Traditional Economic Models Economics Some people prefer to spend an hour doing a task tomorrow than half an hour doing a task today despite the opportunity cost of their time being the same in O O both periods. Some people would be willing to make a large sacrifice in order to help a loved O O one. Some people would turn down a new, higher paying job if it meant spending O O less time with their family. Some people treat $65 they earn differently from $65 they win in a random O O drawing