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The Lemon Principle

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What impact does asymmetric information have on the optimal level of leverage?

Describe the implications of adverse selection and the lemons principle for equity issuance, as well as the empirical implications.

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Solution Summary

This solution looks at the Lemon Principle of investment characteristics. The relationship of performace and managerial efficiency is discussed.

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Review Questions:Principles of Microeconomics

These are a few review questions that have stumped me. Can anyone assist. Thanks!

If the seller knows more about the good than the buyer, there exists:

a. an externality.
b. asymmetric information.
c. moral hazard.
d. a public goods problem

If the market for used computers has only lemons (low-quality computers) then the market:

a. is an example of a thick market.
b. suffers from an adverse selection problem.
c. is a type of monopoly.
d. must be monopolistically competitive

Adverse selection in employment is more likely when:

a. jobs require specific training.
b. everyone is equally qualified for the job.
c. people's abilities are easy to measure.
d. people's abilities are difficult for potential employers to observe.

In a _____market there are few high-quality goods for sale while in a ____market there are many high-quality goods for sale.

a. thin; thicker.
b. thicker; thin.
c. inefficient; efficient.
d. weak; strong.

Suppose buyers in the used car market are willing to pay $3,500 for a plum (high-quality) used car and $1,500 for a lemon (low-quality) used car. If buyers believe that 30% of the used cars on the market are lemons (low quality), what would they be willing to pay for a used car?

a. $2000
b. $2500
c. $2900
d. $3500

A market in which there are neither spillover benefits nor spillover costs is:

a. efficient.
b. in efficient.
c. efficient but not equitable.
d. impossible.

The discoveries from space exploration are examples of:

a. private goods.
b. external goods.
c. public goods.
d. spillover goods.

A college education generates:

a. no benefits.
b. only private benefits.
c. only spillover benefits.
d. both private and spillover benefits.

Arranging matching charitable contributors will______ the free-rider problem and lead to a _____ level of contribution to the public good.

a. increase; smaller.
b. increase; larger.
c. reduce; smaller.
d. reduce; larger.

The theory of government that assumes that the goal of government is to make the government more efficient is called:

a. public choice economics.
b. the public interest view.
c. the efficient markets hypothesis.
d. the voter theory.

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