1.3.4 Information gaps Quiz: Pearson Edexcel Economics A, Unit 1

The 20 questions

1. What is the difference between symmetric and asymmetric information?

   • Symmetric information means both parties have the same information; asymmetric information means one party knows more.
   • Symmetric information means no information is available to either party, while asymmetric information means all information is available.
   • Symmetric information means one party knows more, while asymmetric information means both parties have identical knowledge.
   • Symmetric information is only found in government markets, while asymmetric information is only found in private markets.

2. A used car seller knows about faults that the buyer cannot see. What type of information exists in this market?

   • Perfect information, since the buyer is able to obtain the full details of the car's history at no cost.
   • Symmetric information, since both parties can inspect the car fully before agreeing to any sale in the market.
   • Asymmetric information, since the seller has better information about the car's quality than the buyer.
   • No information, since neither party has any knowledge of the car's condition at the time of sale.

3. How might imperfect market information lead to a misallocation of resources?

   • Buyers always pay the correct price for every good, so the misallocation of resources cannot occur in the market.
   • Imperfect information raises the efficiency of the market by reducing the number of transactions taking place.
   • Buyers may overpay for low-quality goods, or sellers may fail to supply high-quality goods, so resources go to the wrong uses.
   • Sellers always supply exactly what buyers want, so misallocation cannot occur whatever information is available.

4. Which of these is an example of a market where information gaps can lead to misallocation?

   • The market for bread, where all buyers can see the quality and price of each loaf before buying it.
   • The market for newspapers, where prices and content are publicly displayed and fully understood by readers.
   • The market for private health insurance, where insurers may not know the full health risk of each applicant.
   • The market for milk, where the government inspects every carton for quality before it is sold to consumers.

5. Which of these best describes adverse selection in a market?

   • Symmetric information leads both parties to make the same choice, so no problem arises in the market.
   • Asymmetric information leads the party with less information to attract the wrong types, such as high-risk buyers taking cover.
   • Government regulation leads to a fall in the number of buyers who choose to purchase the product.
   • Sellers choose to reduce the quality of goods because buyers are unwilling to pay higher prices in the market.

6. Which of these best describes moral hazard?

   • A party is required by law to disclose all information about a product before selling it to any buyer.
   • A party changes its behaviour after a transaction because it is protected from the full consequences of its actions by a contract.
   • A party refuses to trade because the price is set too low to cover the cost of supplying the good in the market.
   • A party makes a decision before a transaction because it has full knowledge of the other party's characteristics.

7. A bank offers loans without checking the borrower's credit history. Which information problem is most likely to arise?

   • Public goods, since loans are non-rival and non-excludable so that all borrowers can benefit equally.
   • Perfect information, since the bank can predict every borrower's default without any checks in the market.
   • Symmetric information, since the bank knows the borrower's risk without needing to check the credit history at all.
   • Adverse selection, since risky borrowers may be more likely to apply and the bank cannot distinguish them from safe borrowers.

8. Which of these is the most effective way for government to reduce the problems caused by information gaps?

   • Subsidising all producers equally, so that information about quality is no longer needed in the market.
   • Requiring sellers to disclose product information and providing independent quality standards to buyers.
   • Banning all sales of goods where information is imperfect, since markets with information gaps cannot function.
   • Setting a fixed price for every good, so that the quality of the product no longer matters to buyers.

9. In a market for second-hand cars, buyers cannot tell good cars from bad ones. What is the likely market outcome?

   • Sellers provide free warranties for every car, so buyers never need to worry about the quality of cars offered.
   • Buyers offer only a low price for any car, so good sellers may withdraw, leaving mostly low-quality cars for sale.
   • Buyers offer a high price for any car, so all sellers rush to bring their cars to the market at once.
   • Buyers always pay the correct price for each car, so the market allocates resources perfectly without any problem.

10. Which of the following best explains why imperfect information can lead to under-consumption of a good?

    • Buyers who know the benefits perfectly always consume too little, since they never trust the good in the market.
    • Imperfect information has no effect on consumption, since demand depends only on the price of the good.
    • Imperfect information always leads to over-consumption, since buyers consume whatever they see advertised by sellers.
    • Buyers who are unsure of the benefits may not buy the good, even where it would provide a high net benefit.

11. Which market is most likely to suffer from imperfect information about the health effects of a product?

    • A market for a commodity whose quality is identical in all forms and is set by a single international standard.
    • A market for a food product whose long-term health effects are difficult for consumers to assess when they buy it.
    • A market for a product whose health effects are fully labelled and tested by independent bodies before sale.
    • A market for a service that is provided free of charge to every user by the state in the economy.

12. Which of these describes asymmetric information between a doctor and a patient?

    • Both the doctor and the patient know exactly the same information, so there is no asymmetry in the relationship.
    • The doctor usually knows more about the diagnosis and treatment options than the patient, which can affect choices made.
    • Neither the doctor nor the patient has any information about the treatment, so the relationship is symmetric.
    • The patient always knows more about the medical treatment than the doctor, since the patient has the symptoms.

13. Which evaluation of information gaps as a market failure is most accurate?

    • They are important only for government budgets, since information gaps do not affect the allocation of resources.
    • They are never a source of market failure, since all markets have perfect information in every case.
    • They always cause markets to disappear completely, since no trade can take place with any information gaps at all.
    • They are a genuine source of misallocation, but their scale depends on how far reputation, regulation and disclosure reduce them.

14. A buyer is willing to pay 10 pounds for a good of high quality, but cannot tell it apart from a low-quality good that is worth 4 pounds. Which outcome is most likely if the sellers know the quality?

    • All goods are sold at 10 pounds, so the market allocates resources efficiently with no loss of value.
    • Only low-quality goods may be sold at a price the buyers accept, so the high-quality goods are not traded.
    • No goods are sold, since buyers never trade when they cannot be sure of the quality of the product offered.
    • All goods are sold at 4 pounds, but the high-quality goods are sold to the buyers at a discount of 6 pounds.

15. Why does a firm that sells a complex financial product have an incentive to reduce information gaps?

    • The firm is legally required to hide information from customers, so it cannot reduce information gaps at all.
    • Clear information lowers the firm's revenue, since customers buy less when they understand the product fully.
    • Clear information builds trust, so customers may be more willing to buy, reducing the risk of market failure in the product.
    • Information gaps increase the firm's profits, so the firm has no reason to reduce them at any time.

16. Explain how information gaps can lead to a loss of welfare in a market.

    • Consumers may make choices that do not match their true preferences or costs, so resources are used in ways that reduce total welfare.
    • Information gaps always increase welfare, since consumers make more decisions when they have less information in the market.
    • Information gaps increase producer surplus only, so consumers gain welfare while producers lose surplus in every market.
    • Information gaps have no effect on welfare, since welfare depends only on the price of goods and not on consumer choices.

17. Which of these is a common way that insurers reduce adverse selection?

    • Insurers refuse to sell any insurance to anyone, so that the risk is removed from the market altogether.
    • Insurers ask the government to set a single premium for every applicant, so that no screening is needed.
    • Insurers charge the same premium to everyone regardless of risk, so high-risk applicants are never identified at all.
    • Insurers screen applicants, for example with medical questions, and set premiums that reflect the risk of each applicant.

18. A market suffers from information gaps. Which intervention is most likely to improve outcomes for consumers?

    • Subsidies paid to producers in proportion to the number of units they sell, regardless of quality.
    • Price controls that set a maximum price for each product, regardless of its quality or content.
    • Mandatory labelling that tells consumers the key facts about a product before they buy it.
    • A ban on all advertising, so that consumers never see any information about products in the market.

19. A buyer and a seller both know the true quality of a good before trade takes place. Which description applies?

    • Symmetric information, so the price can reflect quality and there is no informational failure in the transaction.
    • Moral hazard, since the seller changes behaviour after the sale because of the terms of the contract.
    • Asymmetric information, since the seller knows the quality while the buyer must rely on the price alone.
    • Imperfect information, since neither party can be sure of the quality until the good has been consumed.

20. Which of these is an example of moral hazard in a market with insurance?

    • A driver who is uninsured drives carefully because the cost of any accident falls on him alone.
    • A driver who buys insurance and then sells the car to a buyer who has better information about its condition.
    • An insurer who sets premiums based on each applicant's full medical history before selling any policy.
    • A driver who is fully insured takes less care on the road because the insurer pays for any damage.

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