EC223 Lecture Notes - Lecture 7: George Akerlof, Financial Intermediary, Adverse Selection

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ambermosquito135

14 Nov 2016

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Document Summary

Transactions costs involve the time and money spent in carrying out financial transactions. They are a major problem in financial markets because investors with only a small amount to invest are faced with large brokerage fees (if they purchase shares of stock) and large denominational units (if they purchase bonds). As such, bonds sold in denominations of ,000, for example, therefore become too costly for the investor with only a few hundred dollars to invest cannot. Furthermore, because of high transactions costs, investors with only a small amount of capital to invest are unable to diversify and thus increase their risk. Financial intermediaries can reduce transactions costs because they can exploit economies of scale. Economies of scale exist when the average total cost of transactions (transactions costs per dollar of transactions) is reduced as the size (scale) of transactions increases. For example, when banks make loans they pay a lawyer once for a contract that can be used many times.

Related Questions

Why do CDs have lower rates of return than stocks?

CDs are much riskier investments than stocks.

CDs are less risky than stocks.

CDs are not taxed while stock s returns are taxable.

CDs are not as liquid as stocks.

Given that most investors tend to be risk averse,

	no one buys risky assets.
	there's a trade-off between risk and return.
	low risk assets provide the best return.
	it must be a superior strategy compared to one that is risk loving.

Which of the following financial assets has both the highest risk and highest return for the period of 1926-2009?

	small company stocks
	large company stocks
	corporate bonds
	Treasury bills

Since all assets typically do not move together, how can investors typically reduce risk?

	purchase only the best performing assets
	diversify one's portfolio across different asset classes
	avoid poor performing assets
	actively manage one's portfolio

Risk that is common to all assets (e.g., common stocks) of a certain type is referred to as

	systematic risk.
	unsystematic risk.
	idiosyncratic risk.
	structural risk.

Which is the best example of idiosyncratic risk?

	a financial crisis
	a lawsuit because the corporation produced a faulty product
	a recession
	rising interest rates

If market participants rely only past stock prices to forecast future stock prices,

	they will be better able to forecast future price increases than future price decreases.
	they will be better able to forecast future price decreases than future price increases.
	they have adaptive expectations.
	they have rational expectations.

Question 11 One potential remedy to the tragedy of the commons is to: never allow a single individual to consume more than one percent of the common resource. criminalize the usage of common resources. allow individuals to use a common resource as long as they receive some benefit from doing so. place a common resource under private ownership. 4 points Question 12 As a result of a positional externality: contestants have a tendency to invest in a series of mutually offsetting investments in performance enhancement. there is generally an underinvestment in performance enhancement. the market price of performance enhancement materials is too high. the quality of performance in competitive situations is lower than the socially optimal level. 4 points Question 13 Which of the following statements is true regarding health insurance? Economics shows that all health related procedures should be free to individuals because the health of an individual is priceless. Total economic surplus would be larger if individuals faced an incentive to only use services when the benefit exceeds their costs. Health maintenance organizations provide an incentive for doctors to prescribe expensive nonessential services. First dollar insurance coverage has likely had very little to do with rising healthcare expenditures since World War II. 4 points Question 14 A strategy that yields a higher payoff no matter what the other players in the game choose is known as a: prisoner's strategy. dominated strategy. dominant strategy. Nash strategy. 4 points Question 15 Based on the diagram below, if the costs of hospital care are constant at $200 per day, and the individual does not incur any cost for each day for hospital care, then: the individual will stay 7 days and there will be no loss in economic surplus. the individual will stay 3 days and there will be no loss in economic surplus. the individual will stay 7 days and there will be lost economic surplus. the individual will stay 3 days and there will be lost economic surplus. 4 points Question 16 Economic research by Manning and colleagues suggests that people with deductible health insurance policies: spend substantially less on health care and have substantially worse health outcomes compared to people with first-dollar insurance coverage. spend substantially more on health care and have substantially better health outcomes compared to people with first-dollar insurance coverage. spend basically the same amount on health care and have substantially worse health outcomes compared to people with first-dollar insurance coverage. spend substantially less on health care and have no measurable difference in health outcomes compared to people with first-dollar insurance coverage. 4 points Question 17 An efficient program for reducing pollution is one for which: all polluters incur the same total costs of abatement. all polluters pay the same amount in taxes to the government. all polluters have the same marginal costs of abatement. all polluters reduce their emissions by the same amount. 4 points Question 18 Given the information on pollution abatement costs of the two firms shown below, which of the following is an efficient combination of pollution reduction? Quantity of pollution abatement Firm A's MC of abatement Firm B's MC of abatement 1 $30 $25 2 $35 $30 3 $40 $35 4 $45 $40 Firm A reduces by 1 ton and Firm B reduces by 1 ton. Firm A reduces by 2 tons and Firm B reduces by 3 tons. Firm A reduces by 4 tons and Firm B reduces by 1 ton. Firm A reduces by 3 tons and Firm B reduces by 2 tons. 4 points Question 19 All of the following are characteristics of perfectly competitive markets except: there are a large number of firms. productive resources are mobile. all firms produce a differentiated product. buyers and sellers are well informed. 4 points Question 20 An advantage of the auction method to pollution abatement is that: it is very expensive to firms. regulators can achieve a desired abatement target without having detailed knowledge of the abatement technologies available to polluters. it requires all firms to reduce by exactly the same amount. it assures that eventually society will reach a level of zero pollution emissions. 4 points Question 21 There are 2 firms each emitting 200 tons of a pollutant. Firm A's abatement costs are constant at $20/ton, and Firm B's abatement costs are constant at $40/ton. The government's goal is to reduce pollution by half. If the government auctions 200 one ton permits to the highest bidder: Firm A will purchase all 200 permits. Firm B will purchase all 200 permits. each firm will buy 100 tons. there is no way to know who the highest bidder for any permit would equal. 4 points Question 22 As a result of economies of scale, as output expands: fixed costs are decreasing. average total costs are decreasing. marginal costs are increasing. total costs are decreasing. 4 points Question 23 Generally, when countries open their borders to free trade: both domestic producers and consumers of imported goods gain. both domestic producers and consumers of exported goods gain. domestic producers of imported goods and domestic consumers of exported goods gain. domestic producers of exported goods and domestic consumers of imported goods gain. 4 points Question 24 Which of the following is the best example of a tariff? South Korea bans imports of U.S. beef because of safety concerns. The U.S. requires toys imported from China to undergo testing for lead content. The U.S. imposes a tax on sugar imported from Brazil. The U.S. restricts the quantity of cars imported from Japan. 4 points Question 25 A means-tested program is a benefit program: in which benefits decline as a recipient's earned income increases. in which all individuals must undergo health screening to be eligible for benefits. in which all recipients exclusively receive benefits through in-kind transfers. that only affects the average income of a specific segment of the population. 4 points Save and Submit Click Save and Submit to save and submit. Click Save All Answers to save all answers.

A channel of distribution:

A) is any series of firms or individuals who participate in the flow of goods and services from producer to consumer or final user.
B) is only needed when products must be stored.
C) must include one or more intermediaries.
D) is only needed when products are sold indirectly.

Which of the following statements about Place decisions is True?

A) Product classes are not related to Place objectives.
B) The product life cycle is not related to Place objectives.
C) Place decisions are short-term decisions that are easy to change.
D) Different market segments may require separate Place arrangements.

Direct _____ involves personal sales contact between a representative of the company and an individual consumer.

A) marketing
B) selling
C) distribution
D) servicing

A manufacturer prefers to produce and ship in large quantities to take advantage of economies of scale. Final consumers often want to purchase in small quantities. This difference between the producer and consumer is a:

A) Discrepancy of assortment.
B) Discrepancy of quantity.
C) Regrouping activity.
D) Discrepancy adjustment

Which of the following best illustrates adjusting "discrepancies of assortment?"

A) General Motors makes Hummer for one product-market and Chevrolet for another product-market.
B) A hardware store sells all the hardware items wanted by most people.
C) Over 310 million U.S. consumers are served by around 330,000 manufacturers.
D) RCA sold more than 2,000,000 TVs last year

Small farmers in the mountains of Peru pick coffee beans by hand, obtaining only a bucket a day. Then they sell them to buyers who put the beans in large bags to be shipped to processors. This regrouping activity is called:

A) Assorting
B) Wholesaling
C) Bulk-breaking
D) Accumulating