19.3 Trade-Off Between Efficiency in Production and Risk Bearing
1) Suppose a plaintiff hires a lawyer to represent her in a court case. The lawyer will be paid a fixed fee. Under this contract,
A) production efficiency is achieved.
B) the client bears all of the risk.
C) the lawyer has an incentive to lie about his hours worked.
D) All of the above.
2) Suppose a plaintiff hires a lawyer to represent her in a court case. The lawyer will be paid by the hour. Under this contract,
A) production efficiency is not achieved.
B) the client bears all of the risk.
C) the lawyer has an incentive to lie about his hours worked.
D) All of the above.
3) In the presence of asymmetric information,
A) all contracts are efficient.
B) efficiency in risk bearing cannot be achieved.
C) a trade-off exists between risk-bearing efficiency and production efficiency.
D) no contracting will take place.
4) Suppose a plaintiff hires a lawyer to represent her in a court case. The lawyer will receive a share of the settlement if the plaintiff wins. Under this contract,
A) production efficiency cannot be achieved.
B) the client bears all of the risk.
C) the lawyer bears all of the risk.
D) the risk is shared.
5) Suppose a plaintiff hires a lawyer to represent her in a court case. She agrees to pay the lawyer a wage per hour. She knows precisely what the lawyer should do and how long each activity should take, and she can verify that the lawyer has correctly completed each activity. She can terminate the contract at any time. With this contract,
A) the lawyer bears all the risk.
B) the risk is shared by the lawyer and the plaintiff.
C) production efficiency can be achieved.
D) production efficiency is impossible.
6) Suppose a plaintiff hires a lawyer to represent her in a court case. Under which of the following contracts is production efficiency assured?
A) The lawyer is paid by the hour.
B) The lawyer receives a share of the settlement.
C) The lawyer receives a fixed fee.
D) The lawyer pays the client a fee for the right to the entire settlement.
7) Suppose a plaintiff hires a lawyer to represent her in a court case. To which of the following contracts would a highly risk-averse plaintiff agree?
A) The lawyer is paid by the hour.
B) The lawyer receives a share of the settlement.
C) The lawyer receives a fixed fee.
D) The lawyer pays the client a fee for the right to the entire settlement.
8) Under which one of the following conditions would a lawyer accept a case on a contingent basis?
A) The lawyer is risk averse.
B) The client is risk loving.
C) The lawyer has several cases on a contingent basis with payoffs that are not perfectly positively correlated.
D) The lawyer is more risk averse than the client is.
9) Under which one of the following contracts does an agent have the least incentive to behave opportunistically?
A) The agent pays a fixed fee to the principal for the right to all future payoffs.
B) The agent works for the principal on an hourly basis.
C) The agent receives a share of the profit.
D) The agent works for the principal on a per unit basis.
10) Suppose a plaintiff hires a lawyer to represent her in a court case. Under which of the following contracts is efficiency in risk bearing assured?
A) The lawyer is paid by the hour.
B) The lawyer receives a share of the settlement.
C) The lawyer receives a fixed fee.
D) It is impossible to determine without the degree of risk aversion for each.
11) One reason that lawyers might prefer a contingent contract when representing a plaintiff in a tort case is that
A) lawyers are risk neutral.
B) diversification of many cases allows lawyers to reduce risk.
C) lawyers are typically confident about winning every case.
D) hourly rates for lawyers are usually very low.
12) A contingent contract can create production inefficiency; however, many principals accept this because
A) inefficiency is inevitable.
B) monitoring is costless.
C) risk is reduced.
D) profit will increase as a result.
13) If an agent is risk neutral and a principal is risk averse, which of the following contracts would be efficient in risk bearing?
A) A fixed fee is paid to the agent.
B) A fixed fee is paid to the principal.
C) An hourly rate is paid to the agent.
D) The agent enjoys a share of the profit.
For the following, please answer “True” or “False” and explain why.
14) In the presence of asymmetric information with costless monitoring and enforcement, a hire contract results in production efficiency.
15) Sam hires an attorney to present a court case. If Sam wins the case, he will receive some money. This payoff is a function of the attorney’s hours and which judge is assigned the case that day. Judge A is very understanding toward people in Sam’s position, but judge B is very harsh toward people like Sam. Is it possible for Sam to get the attorney to deliver the optimal amount of effort and make the attorney bear all of the risk?
16) Sarah’s demand for routine medical visits is q = 10 – 0.2p when she is healthy and q = 20 – 0.2p when she is sick. Medical visits cost $50 each if Sarah has no medical insurance. She is sick 20% of the time. Sarah is considering two different insurance plans. One offers free medical visits; the other plan costs less up front but requires that Sarah pay $5 per medical visit. Compare the two plans in terms of the trade-off be
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