Exam 5: Uncertainty and Consumer Behavior

Scenario 5.5: Engineers at Jalopy Automotive have discovered a safety flaw in their new model car. It would cost $500 per car to fix the flaw, and 10,000 cars have been sold. The company works out the following possible scenarios for what might happen if the car is not fixed, and assigns probabilities to those events: Scenario Probability Cost A. No one discovers flaw .15 $0 B. Government fines firm .40 $10 million (no lawsuits) C. Resulting lawsuits are lost .30 $12 million (no government fine) D. Resulting lawsuits are won .15 $2 million (no government fine) -Refer to Scenario 5.5. Jalopy Automotive's executives,

Dante has two possible routes to travel on a business trip. One is more direct but more exhausting, taking one day but with a probability of business success of 1/4. The second takes three days, but has a probability of success of 2/3. If the value of Dante's time is $1000/day, the value of the business success is $12,000, and Dante is risk neutral,

Behavioral economists argue that asset price bubbles and other examples of herd behavior may be due to biases resulting from the law of small numbers. In particular, the investors may observe unusually ________ returns for some asset and use this limited information to ________ the probability that returns will be high in the future.

Which of the following statements is NOT true?

Figure 5.3 -The individual pictured in Figure 5.3

Scenario 5.3: Wanting to invest in the computer games industry, you select Whizbo, Yowzo and Zowiebo as the three best firms. Over the past 10 years, the three firms have had good years and bad years. The following table shows their performance: -Refer to Scenario 5.3. Based on the 10 years' past performance, what is the probability of a good year for Zowiebo?

The variance of an investment opportunity:

Suppose an investor equally allocates their wealth between a risk-free asset and a risky asset. If the MRS of the current allocation is less than the slope of the budget line, then the investor should:

The information in the table below describes choices for a new doctor. The outcomes represent different macroeconomic environments, which the individual cannot predict.Table 5.3 -Refer to Table 5.3. Rank the doctor's job options in expected income order, highest first.

Scenario 5.9: Torrid Texts, a risk-neutral new firm that specializes in making college textbooks more interesting by inserting contemporary material wherever possible, is planning for next year's production and must decide how many paper producers to contract with. It knows fairly well what the general demand for textbooks is, but is uncertain how faculty will react to this new material. If faculty react very negatively, the firm expects course orders to be down. The executives at Torrid believe that the likelihood of a positive faculty response is 75%. The table below contains profit information under the different possible outcomes. Producers Faculty Reaction Expected Contracted Negative Positive Profit 1 $3 million $30 million $23.25 million 2 $1 million $60 million $45.25 million -Refer to Scenario 5.9. The value to Torrid Texts of complete information is

Scenario 5.4: Suppose an individual is considering an investment in which there are exactly three possible outcomes, whose probabilities and pay-offs are given below: The expected value of the investment is $25. Although all the information is correct, information is missing. -Refer to Scenario 5.4. What is the pay-off of outcome C?

How might department stores best protect themselves against the risk of recession?

Scenario 5.9: Torrid Texts, a risk-neutral new firm that specializes in making college textbooks more interesting by inserting contemporary material wherever possible, is planning for next year's production and must decide how many paper producers to contract with. It knows fairly well what the general demand for textbooks is, but is uncertain how faculty will react to this new material. If faculty react very negatively, the firm expects course orders to be down. The executives at Torrid believe that the likelihood of a positive faculty response is 75%. The table below contains profit information under the different possible outcomes. Producers Faculty Reaction Expected Contracted Negative Positive Profit 1 $3 million $30 million $23.25 million 2 $1 million $60 million $45.25 million -Refer to Scenario 5.9. Without additional information, Torrid Texts would

Which of the following statements is NOT true?

The risk-return indifference curves for a risk-neutral investor are:

A new toll road was built in Southern California between San Juan Capistrano and Costa Mesa. On average, drivers save 10 minutes taking this road as opposed to the old road. The toll is $2; the fine for not paying the toll is $76. The probability of catching and fining someone who does not pay the toll is 90%. Individuals who take the road and pay the toll must therefore value 10 minutes at a minimum

Some recent developments in financial research focus on ways to make portfolio allocations and other investment decisions in ways that largely ignore the possible gains but protect against large losses. These tools are designed to reflect ________ behavior among investors.

The difference between the utility of expected income and expected utility from income is

Figure 5.3 -The individual pictured in Figure 5.3

Which of the following is NOT an example of consumer behavior consistent with the standard assumptions of microeconomic theory?