Exam 20: Uncertainty and Information

Option A provides $9,000 with probability 50 percent or $11,000 with probability 50 percent. Option B provides $8,000 with probability 50 percent or $12,000 with probability 50 percent. For most people the cost of risk associated with B is

Soran is risk averse. If her wealth rises by $100, her total utility increases by 300. If her wealth increases, her total utility will decrease

The International Maritime Bureau said the waters off Somalia are the world's most dangerous, accounting for nearly a third reported pirate attacks worldwide between January and September 2008. Suppose all boats are insured to $100,000 and pay a premium of $10,000 each. Suppose 10 out of 100 boats are attacked by pirates and these 10 file claims with their insurance. What is the value of the claims?

-Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. Her utility of wealth curve is shown in the figure above. What's Adriana's cost of risk?

For a risk averse person, an increase in wealth brings ________ total utility of wealth and ________ marginal utility of wealth.

If Ringo is risk averse, at a wealth of $200,000 his utility of wealth curve has a ________ slope and his marginal utility of wealth is ________ than at a wealth of $100,000.

Moral hazard occurs ________ an agreement is made and when monitoring the parties to the agreement is ________.

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be completely destroyed, would this homeowner buy insurance?

Explain the concept of moral hazard. Give an example.

-The above figure shows how an individual evaluates a bet in which he or she has a 0.5 probability of receiving $20 and a 0.5 probability of receiving $200. The individual would be indifferent between

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, the highest price for insurance this person would pay is

Insurance companies

Without warranties, used car buyers can assume that all used cars are "lemons" because of

-Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. What is the maximum insurance premium that Steve is willing to pay?

-Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. With no insurance, Steve's expected utility is

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, would this person buy a $20,000 insurance policy to replace the house if destroyed?

-Mike has the utility of wealth curve shown in the figure above. He owns a car worth $20,000, and that is his only wealth. There is a 10 percent chance that Mike will have an accident within a year. If he does have an accident, his car is worthless. a) What is Mike's expected utility? b) What is the maximum amount that Mike is willing to pay for auto insurance? c) Suppose all car owners are like Mike insofar as they have a 10 percent chance of having an accident. An insurance company agrees to pay each person who has an accident the full value of his or her car. The company's operating expenses are $1,000. What is the minimum insurance premium that the company is willing to accept? d) Will Mike buy the company's policy? Why or why not?

-Lucy works as a college instructor for a fixed annual salary of $30,000. She is considering quitting this job and becoming a real estate broker. Lucy believes that as a realtor she has a 40 percent chance to make $60,000 per year and a 60 percent chance to make $25,000 a year. The figure above shows Lucy's total utility of wealth curve (U). Lucy will decide to ________ and she will definitely make this choice because it gives her a greater expected ________.

-Nancy's utility of wealth curve is given in the above figure. She is faced with a risky proposition which yields an income of $50 one-third of the time, $100 one-third of the time, and $150 one-third of the time. Her expected utility is

What is private information and what problems does it create?