Question

True/False

6.A trade between two people is an example of an externality.

7.If a pure public good is provided by voluntary contributions, economic theory predicts that in general too little will be supplied.

8.Economists define public goods to be those goods that are supplied by the government and private goods to be those goods that are supplied by the private sector.

9.A life insurance company must be concerned about the possibility that the people who buy life insurance may tend to be less healthy than those who do not. This is an example of adverse selection.

10.An insurance company must be concerned about the possibility that someone will buy fire insurance on a building and then set fire to it. This is an example of adverse selection

Answer 1

6.A trade between two people is an example of an externality. : False

Not every trade is an externality. Externalities are those, when an individual causes a cost or a benefit without bearing the financial burden of the cost or benefit. Example would be firms causing pollution(cost to the environment, wihtout having to pay for it) or investment in education(benefit not directly reaped by the government).

7.If a pure public good is provided by voluntary contributions, economic theory predicts that in general too little will be supplied. : True

This is true. A public good is one which is provided without profit to all members of society. Since there is no incentive of profit, voluntary contribution would be too little.

8.Economists define public goods to be those goods that are supplied by the government and private goods to be those goods that are supplied by the private sector. : False

This is not true, as public goods can be provided by private organisations and similarly private goods can be provided by governments. The difference between public and private goods is that the benefits derived from public goods are not limited to those who pay for it, unlike private goods where only those who pay have access to the product.

9.A life insurance company must be concerned about the possibility that the people who buy life insurance may tend to be less healthy than those who do not. This is an example of adverse selection. : False

The given statement is an example of moral hazard. Because of insurance the cost of healthcare and the cost of falling ill reduces. Hence the consumers of insurance have less incentive to stay healthy. This is called moral hazard.

10.An insurance company must be concerned about the possibility that someone will buy fire insurance on a building and then set fire to it. This is an example of adverse selection. : True

This is true. Adverse selection is when at the time of giving erthe insurance, the company is unaware if a person is more likely to end up claiming the insurance, i.e. the company doesn't have perfect information about the buyer's intention to set the building on fire.

This is not moral hazard, as moral hazard is when after buying the insurance a person decided to take risks and not be precautionary about fire protocols. However, here the buyer before the transaction had decided to set the building on fire. An analogy to explain the same would be: moral hazard - a person buys insurance and starts smoking and drinking; adverse selection - a heavy smoker purchases insurance without the insurance company knowing that he/she is a heavy smoker.