Exam 5: Uncertainty and Consumer Behavior

Scenario 5.8: Risk-neutral Icarus Airlines must commit now to leasing 1, 2, or 3 new airplanes. It knows with certainty that on the basis of business travel alone, it will need at least 1 airplane. The marketing division says that there is a 50% chance that tourism will be big enough for a second plane only. Otherwise, tourism will be big enough for a third plane. This, plus revenue information, yields the following table: Planes Tourism Revenue Expected Leased Light Heavy Profit 2 $90 million $30 million $60 million 3 $10 million $140 million $75 million -Refer to Scenario 5.8. Given that the two outcomes are equally likely, Icarus Airlines' expected profit under complete information would be

Which price index measures the change in housing prices from repeated sales information?

Assume that an investor invests in one risky and one risk free asset. Let σ_m be the standard deviation of the risky asset and b the proportion of the portfolio invested in the risky asset. The standard deviation of the portfolio is then equal to ________.

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 standard deviation of the investment?

Virginia Tyson is a widow whose primary income is provided by earnings received from her husband's $200,000 estate. The table below shows the relationship between income and total utility for Virginia. Income Total Utility 5,000 12 10,000 22 15,000 30 20,000 36 25,000 40 30,000 42 a. Construct the marginal utility table for Virginia. What is her attitude toward risk? Explain your answer including a description of the marginal utility for individuals whose risk preferences are different from Virginia's. b. Virginia is currently earning 10% on her $200,000 in a riskless investment. Alternatively, she could invest in a project that has a 0.4 probability of yielding a $30,000 return on her investment and a 0.6 probability of paying $10,000. Should she alter her strategy and move her $200,000 to the more risky project?

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 -In Table 5.3, the standard deviation is

United Plastics Company produces large plastic cups in a variety of colors. United can produce plain plastic cups that are sold in department stores in inexpensive ten cup bundles. Alternatively, United can sell Novelty Cups which are imprinted with slogans and designs. The printed cups cost more to produce, but they sell for a higher price. The appropriate strategy for United depends upon the state of the economy. Plain cups do better during a recession, while Novelty Cups earn higher profits during normal economic conditions. During a recession, United will earn a $100,000 profit selling plain cups and $40,000 with the Novelty line. Under normal economic conditions, United will earn $120,000 with the plain cups and a $200,000 profit with Novelty Cups. United currently does not use economic forecasts and simply assigns equal probabilities to a recession and normal conditions. a. Using the probabilities assumed by United, what is the expected value of each alternative? Which alternative should the firm pursue? (Your recommendation should include separate recommendations for alternative attitudes toward risk.) b. Calculate and interpret the value to the firm of complete information.

Table 5.4 -Refer to Table 5.4. If outcomes 1 and 2 are equally likely at Job A, then in absolute value

Scenario 5.2: Randy and Samantha are shopping for new cars (one each). Randy expects to pay $15,000 with 1/5 probability and $20,000 with 4/5 probability. Samantha expects to pay $12,000 with 1/4 probability and $20,000 with 3/4 probability. -Refer to Scenario 5.2. Samantha's expected expense for her car is

Mel and Christy are co-workers with different risk attitudes. Both have investments in the stock market and hold U.S. Treasury securities (which provide the risk free rate of return). Mel's marginal rate of substitution of return for risk ( / MU R_P, σ_{P) is} = where RP is the individual's portfolio rate of return and σ_P is the individual's portfolio risk. Christy's = . Each co-worker's budget constraint is R_{P =} R_F + σ_P, where R_j is the risk-free rate of return, R_m is the stock market rate of return, and σ_m is the stock market risk. Solve for each co-worker's optimal portfolio rate of return as a function of R_j, R_m, and σ_m.

Joan Summers has $100,000 to invest and is considering two alternatives. She can buy a risk free asset that will pay 10% or she can invest in a stock that has a 0.4 chance of paying 15%, a 0.3 chance of paying 18%, and a 0.3 chance of providing a 6% return. Joan plans to invest $70,000 in the stock and $30,000 in the risk free asset. a. Determine the expected percentage return on the stock and the standard deviation. b. Calculate the weighted average return on the portfolio, given the planned investment strategy outlined above. c. Determine the standard deviation for the portfolio. d. Write the equation that represents the budget line in the risk-return tradeoff. What is the slope of the budget line? Interpret this slope.

The budget line in portfolio analysis shows that

Figure 5.1 -In Figure 5.1, the marginal utility of income is

Blanca has her choice of either a certain income of $20,000 or a gamble with a 0.5 probability of $10,000 and a 0.5 probability of $30,000. The expected value of the gamble:

Table 5.4 -Refer to Table 5.4. If outcomes 1 and 2 are equally likely at Job A, and if at Job B the $20 outcome occurs with probability .1, and the $50 outcome occurs with probability .9, then

One reason individuals are willing to pay for information in uncertain situations is that information

Based on what we know about asset price formation, what steps can a government use to restrict the formation of an asset price bubble?

Scenario 5.7: As president and CEO of MegaWorld industries, Natasha must decide on some very risky alternative investments. Consider the following: -Refer to Scenario 5.7. Since Natasha is a risk-neutral executive, she would choose

Which of the following events will help to burst an asset price bubble?

What is the advantage of the standard deviation over the average deviation?