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Chapter 17: Problem 3

A major university bans the assignment of D or \(\mathrm{F}\) grades. It defends its action by claiming that students tend to perform above average when they are free from the pressures of flunking out. The university states that it wants all its students to get As and Bs. If the goal is to raise overall grades to the B level or above, is this a good policy? Discuss this policy with respect to the problem of moral hazard.

Short Answer

Expert verified
From a moral hazard perspective, this policy is problematic. It can lead to less effort from students, as they are no longer incentivized to avoid low grades. It could potentially increase the average grade but at the cost of genuine learning and intellectual growth, which is the ultimate goal of education.

Step by step solution

01

Understanding the Concept of Moral Hazard

Moral hazard refers to the situation where one party's behavior changes towards riskier conduct because another party bears the associated costs. In this context, this means students might decrease their effort and engagement with their studies due to the absence of the risk of receiving low grades (D or F).
02

Applying the Concept of Moral Hazard to the University's Policy

According to the policy, the university assigns grades only above B. This removes the pressure of failing, however, it can potentially lead to students not putting in maximum efforts since they are aware that they wouldn't receive low grades irrespective of their performance. This provides potential for moral hazard to arise as students could take advantage of the system.
03

Assessing the Policy in Light of the Moral Hazard Principle

If the goal is to raise overall grades to the B level or above, it might on one hand help in achieving this goal since all students will formally reach the goal by getting at least B grades. However, this policy may not reflect their real academic performance and does not necessarily mean students have improved their understanding or skills, which should be the ultimate goal of education. Perhaps other measures could help provide a solution to this problem. Forcing the students to learn and understand the material to pass threshold examinations, for example, could ensure academic achievement without creating a moral hazard.

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Most popular questions from this chapter

Two used car dealerships compete side by side on a main road. The first, Harry's Cars, always sells high-quality cars that it carefully inspects and, if necessary, services. On average, it costs Harry's \(\$ 8000\) to buy and service each car that it sells. The second dealership, Lew's Motors, always sells lower-quality cars. On average, it costs Lew's only \(\$ 5000\) for each car that it sells. If consumers knew the quality of the used cars they were buying, they would pay \(\$ 10,000\) on average for Harry's cars and only \(\$ 7000\) on average for Lew's cars. Without more information, consumers do not know the quality of each dealership's cars. In this case, they would figure that they have a \(50-50\) chance of ending up with a high-quality car and are thus willing to pay \(\$ 8500\) for a car Harry has an idea: He will offer a bumper-to-bumper warranty for all cars that he sells. He knows that a warranty lasting \(Y\) years will cost \(\$ 500 Y\) on average, and he also knows that if Lew tries to offer the same warranty, it will cost Lew \(\$ 1000 Y\) on average. a. Suppose Harry offers a one-year warranty on all of the cars he sells. i. What is Lew's profit if he does not offer a oneyear warranty? If he does offer a one-year warranty? ii. What is Harry's profit if Lew does not offer a one-year warranty? If he does offer a one-year warranty? iii. Will Lew's match Harry's one-year warranty? iv. Is it a good idea for Harry to offer a one-year warranty? b. What if Harry offers a two-year warranty? Will this offer generate a credible signal of quality? What about a three-year warranty? c. If you were advising Harry, how long a warranty would you urge him to offer? Explain why.

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Professor Jones has just been hired by the economics department at a major university. The president of the board of regents has stated that the university is committed to providing top-quality education for undergraduates. Two months into the semester, Jones fails to show up for his classes. It seems he is devoting all his time to research rather than to teaching. Jones argues that his research will bring prestige to the department and the university. Should he be allowed to continue exclusively with research? Discuss with reference to the principal-agent problem.
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