Question 1
Adverse selection and moral hazard arise because of
◦ asymmetric information.
◦ selection problems.
◦ risk aversion.
◦ mechanism designs for dealing with informational problems.
Question 2
You are in the market for a used 2013 Toyota Corolla. You know that half of the 2013 Corollas are lemons and half are peaches. If you could be assured that the Corolla you were buying was a peach, you would be willing to pay up to $12,000. On the other hand, you would only be willing to pay $4,000 for a lemon. You have no ability to discern whether any particular Corolla is a lemon or a peach. Sellers of Corollas, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $3,000 or more and peach sellers will be willing to sell their cars for $9,000 or more. If you are risk neutral, you are willing to offer ________ and ________ are willing to sell you their car.
◦ $4,000 for a car of unknown quality; lemon owners only
◦ $6,000 for a car of unknown quality; lemon owners only
◦ $8,000 for a car of unknown quality; lemon owners only
◦ $9,000 for a car of unknown quality; both lemon and peach owners
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