Market failure—asymmetric information (HL only): Practice Questions

• a.Information becomes symmetric as the premium reflects the average risk of the entire population.
• b.Low-risk individuals will over-consume insurance, leading to social surplus.
• c.The insurance pool will become increasingly composed of high-risk individuals, potentially leading to a market collapse.
• d.The provider will achieve allocative efficiency by equalizing marginal benefit and marginal cost.

• a.Monopolistic firms restrict supply to drive up prices, causing consumers to exit the market.
• b.Government intervention in the form of price ceilings prevents the market from reaching equilibrium.
• c.High-quality goods are driven out of the market because buyers, unable to distinguish quality, are only willing to pay an average price.
• d.Externalities associated with the consumption of the good result in a quantity produced that is less than the social optimum.

• a.An uninformed party takes actions to induce the informed party to reveal private information.
• b.An informed party takes an observable action, such as obtaining a university degree, to provide information to an uninformed party.
• c.A government mandates that all used car sellers provide a comprehensive history report to potential buyers.
• d.An insurance company requires all applicants to undergo a medical examination before providing coverage.

• a.They serve as a government-mandated price floor to ensure equitable wages.
• b.They eliminate moral hazard by ensuring employees always work at maximum capacity after being hired.
• c.They function as a form of screening used exclusively by employees to select the best firms.
• d.They act as a signal to reduce the information gap between the employer and the prospective employee.

• a.Adverse selection
• b.Signaling
• c.Screening
• d.Moral hazard

Write your answer out first, then check it against the worked solution.