Questions marked with an asterisk are answered at the end of the book in an appendix, "Answers to Selected Questions and Problems."
1. How can economies of scale help explain the existence of financial intermediaries?
*2. Describe two ways in which financial intermediaries help lower transaction costs in the economy.
3. Would moral hazard and adverse selection still arise in financial markets if information were not asymmetric? Explain.
*4. How do standard accounting principles required by the government help financial markets work more efficiently?
5. Do you think the lemons problem would be more severe for stocks traded on the New York Stock Exchange or those traded over-the-counter? Explain.
*6. Which firms are most likely to use bank financing rather than to issue bonds or stocks to finance their activities? Why?
7. How can the existence of asymmetric information provide a rationale for government regulation of financial markets?
*8. Would you be more willing to lend to a friend if she put all of her life savings into her business than you would if she had not done so? Why?
9. Rich people often worry that others will seek to marry them only for their money. Is this a problem of adverse selection?
*10. The more collateral there is backing a loan, the less the lender has to worry about adverse selection. Is this statement true, false, or uncertain? Explain your answer.
11. How does the free-rider problem aggravate adverse selection and moral hazard problems in financial markets?
*12. Explain how the separation of ownership and control in American corporations might lead to poor management.
13. Is a financial crisis more likely to occur when the economy is experiencing deflation or inflation? Explain.
*14. How can a stock market crash provoke a financial crisis?
15. How can a sharp rise in interest rates provoke a financial crisis?
1. In this chapter we discuss the lemons problem and its effect on the efficient functioning of a market. This theory was initially developed by George Akerlof. Go to www.nobel.se/economics/laureates/2001/public.html. This site reports that Akerlof, Spence, and Stiglitz were awarded the Nobel prize in economics in 2001 for their work. Read this report down through the section on George Akerlof. Summarize his research ideas in one page.
2. This chapter discusses how an understanding of adverse selection and moral hazard can help us better understand financial crises. The greatest financial crisis faced by the U.S. has been the Great Depression from 1929-1933. Go to www.amatecon.com/greatdepression .html. This site contains a brief discussion of the factors that led to the Depression. Write a one-page summary explaining how adverse selection and moral hazard contributed to the Depression.
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