Exam 5: Uncertainty and Consumer Behavior

Use the following statements to answer this question: I. Subjective probabilities are based on individual perceptions about the relative likelihood of an event. II. To be useful in microeconomic analysis, all interested parties should agree on the values of the relevant subjective probabilities for a particular problem.

Fine-dining restaurants commonly provide statements in their menus such as, "A 20% gratuity will be added to all checks for parties of six or more patrons." Given that this statement tends to raise the level of tips or gratuities left by other groups of diners, the statement is a good example of:

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. The expected cost to the firm if it does not fix the car is

Consider the following statements when answering this question; I. The variance of the returns of an investor's portfolio can be reduced by selling assets from the portfolio, and investing the proceeds in other assets where returns are positively correlated with the portfolio's remaining assets. II. The value of complete information is always positive.

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. Given that the probability of a positive faculty response is 75%, Torrid Texts' expected profit under complete information would be

When did housing prices start to fall during the most recent housing boom?

Assume that two investment opportunities have identical expected values of $100,000. Investment A has a variance of 25,000, while investment B's variance is 10,000. We would expect most investors (who dislike risk) to prefer investment opportunity

Scenario 5.6: Consider the information in the table below, describing choices for a new doctor. The outcomes represent different macroeconomic environments, which the individual cannot predict. -Refer to Scenario 5.6. If the doctor is risk-averse, she would accept

The correlation between an asset's real rate of return and its risk (as measured by its standard deviation) is usually

Which major asset experienced a price bubble just before the housing price bubble of 2006-2009?

Suppose your instructor gave hats with your school's logo to half of your economics classmates. She then asked these students to value the hats, and the average response was $9 per hat. Under the endowment effect, we should expect that the average value assigned by the economics students who did NOT receive the hats to be:

Amos Long's marginal utility of income function is given as: MU(I) = I^1.5, where I represents income. From this you would say that he is

We may not be able to fully remove risk by diversification if:

Daring Dora holds 90% of her assets in high-technology stocks, earning 12%, and 10% in long-term government bonds, earning 6%. The expected return on her portfolio

By 2011, how much had U.S. housing prices declined from their peak in 2006?

Other things equal, expected income can be used as a direct measure of well-being

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. Without additional information, Icarus Airlines would

Jack is near retirement and worried that if the stock market falls he will not be able to wait to take his funds out, and will have to sell at the bottom of the market. Richard thinks the probability of a stock market downturn is the same, but he is only 40 and could therefore wait for another turnaround. They face the same budget line. Jack's risk/return indifference curve

Blanca would prefer a certain income of $20,000 to a gamble with a 0.5 probability of $10,000 and a 0.5 probability of $30,000. Based on this information:

C and S Metal Company produces stainless steel pots and pans. C and S can pursue either of two distribution plans for the coming year. The firm can either produce pots and pans for sale under a discount store label or manufacture a higher quality line for specialty stores and expensive mail order catalogs. High initial setup costs along with C and S's limited capacity make it impossible for the firm to produce both lines. Profits under each plan depend upon the state of the economy. One of three conditions will prevail: growth (probability = 0.3) normal (probability = 0.5) recession (probability = 0.2) The outcome under each plan for each state of the economy is given in the table below. Figures in the table are profits measured in dollars. The probabilities for each economic condition represent crude estimates. Economic Condition Discount Line Specialty Line Growth 250,000 400,000 Normal 220,000 230,000 Recession 140,000 20,000 a. Calculate the expected value for each alternative. b. Which alternative is more risky? (Calculate the standard deviation of profits for each alternative.) c. Taking into account the importance of risk, which alternative should an investor choose?