For each of the following situations, identify the principal and the agent, desc
ID: 2441074 • Letter: F
Question
For each of the following situations, identify the principal and the agent, describe the information symmetry involved, state if it is a moral hazard or adverse selection (if it is adverse selection, also state if it is signaling or screening) and explain how the moral hazard or adverse selection (it is one or the other for each answer) has been reduced (4 points):
a. Dental insurance companies offer free annual check-ups
b. McDonald’s pays twice the minimum wage to high school students.
c. Budweiser sponsors the Super Bowl half-time show.
d. Hyundai (a Korean auto manufacturer) provides a 100,000-mile warranty on its new cars.
Explanation / Answer
A. Dental insurance... -
The insurance company is the principal and
The insured is the agent.
Information asymmetry - Only the agent knows how well he takes care of his teeth. This is the case of moral hazard.
How to reduce it - By checking the insured’s teeth each year, the insurance company can better monitor the behaviour of the insured and reduce major future claims.
B. McDonald's pays twice ....
McDonald’s is the principal and the student is the agent.
Information asymmetry - McDonald’s does not know how hard the student works. This is case of moral hazard.
How to reduce it - By paying above market wages, McDonald’s increases the cost of shirking and the cost of being fired. The worker is less likely to shirk.
C. Budweiser sponsors the ....
Beer buyer's is the principal and the Budweiser is the agent.
Information asymmetry - Beer buyers don’t know the quality of Budweiser as well as Budweiser.
It is the case of adverse selction ( signalling) - Budweiser signals high quality with expensive advertising because they could only afford to do it.
How to reduce - if they could generate repeat buyers. Customers are able to choose a high quality beer.
D. Hyundai ....
Buyer is the principal and Hyundai is the agent.
Information asymmetry - Buyers may be unsure of the quality of Hyundai cars because they are relatively new to the European market.
This is the case of adverse selection (signalling)
Hyundai signals high quality with a long warranty and how to reduce - buyers are able to select high quality cars.
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