Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 1
What is likely to have its cause in the separation of ownership and control in a firm?
Answer: C.
When ownership and control are separated, shareholders own the firm but salaried managers run it, the two parties have different objectives and unequal information. Shareholders (the principals) want profit maximised; managers (the agents) may prefer growth, prestige, a larger empire or an easier life, and they know far more about the firm's day-to-day operations than the owners can observe. That combination of divergent aims and asymmetric information is precisely the principal–agent problem, and it is why firms use share options and profit-related pay to align managers' rewards with owners' interests.
Why the other options are wrong:
- A, contestable markets, is a market structure defined by the absence of barriers to entry and exit. It concerns competitive conditions between firms, not the internal relationship between owners and managers.
- B, diseconomies of scale, arises when a firm grows so large that average costs rise, typically through coordination and communication difficulties. Size causes it, not the ownership structure, a large owner-managed firm can suffer them too.
- D, the prisoner's dilemma, describes strategic interaction between rival firms, explaining why oligopolists find collusion hard to sustain. It is about competitors, not about the inside of a single firm.
What this practice covers
Real questions, the answer key from the mark scheme, and the explanation that goes with it. Each one is marked the moment you pick, the correct option is shown whether or not you found it, and the full explanation opens either way. No account needed to answer them.
These questions are drawn from past Cambridge papers, mapped across to this topic because the concept is the same. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on asymmetric information, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Confusing adverse selection with moral hazard. Remember: before/characteristics versus after/behaviour.
- Describing plain ignorance rather than an asymmetry between the two parties.
- Assuming only government can respond, and ignoring signalling and screening.
- Forgetting that compulsory insurance addresses adverse selection but not moral hazard.
- Treating any reassurance as a signal, a signal must be costly to fake.
- Stating that the market fails without explaining the mechanism by which good products or low-risk customers are driven out.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Asymmetric Information revision notes.