Exam 20: Uncertainty and Information

Buying insurance is similar to

For a risk-averse individual, as wealth increases, total utility ________ and marginal utility ________.

-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, what is the person's cost of risk?

Suppose Nara could invest her $1000 in a savings account or she could invest in the stock market. After one year, the savings account has a guaranteed 5 percent interest rate and the stock market has a 10 percent chance of tripling her money, and 90 percent chance of losing it all. What is Nara's expected wealth if she places her money in the stock market?

If you have private information that you are a safer driver than your record indicates, you are likely to buy an insurance policy with

-Dana's utility of wealth is 65 units at $3,000, 80 units at $5,000, and 95 units at $9,000. Starting from zero wealth, he must choose between options A and B. Option A gives him $5,000 for sure. Option B gives him $3,000 with probability 0.5 or $9,000 with probability 0.5. Dana will

Paying salespeople a fixed wage contract, one in which income does not depend on the volume of sales, avoids

In the used car market without warranties, adverse selection results in

Suppose there are only two kind of cars in the market for used cars: lemons and good cars. A lemon is worth $1,000 both to its current owner and to anyone who buys it. A good car is worth $8,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car, and there is no warranty. What is the prevailing price of a used car?

Stan, who is risk averse, can invest in project A or project B. Project A returns $3,000 with probability 1/2 and $9,000 with probability 1/2. Project B returns nothing with probability 1/2 and $12,000 with probability 1/2. For Stan, project A has

-Gunnar can work as a campus security officer at a guaranteed salary of $20,000 per year or as a real estate agent. If Gunnar works as a real estate agent, there is a 50 percent chance that he will earn $10,000 per year and a 50 percent chance that he will earn $30,000 per year. Based on the above table, to maximize his expected utility, Gunnar will

When Sardar buys insurance, on net he

In an ad for insurance, the text reads "Life's an adventure, and there are plenty of perils awaiting your jewelry: a lost or broken stone, theft, accidental loss, damage, mysterious disappearance Have you thought about insurance?" What is the economic reasoning for an individual to buy insurance?

Consider a market for used cars. Suppose there are only two kinds of cars: lemons and good cars. A lemon is worth $1,500 both to its current owner and to anyone who buys it. A good car is worth $6,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car. What do economists call the problem that buyers of used cars face? What kind of cars (lemons, good cars, or both) are traded? Explain and substantiate your answer.

Mel's utility of wealth is 130 units at $3,000, 160 units at $5,000, and 190 units at $9,000. Starting from zero wealth, he must choose between options A and B. Option A gives him $5,000 for sure. Option B gives him $3,000 with probability 0.4 or $9,000 with probability 0.6. Mel

A risk-averse person's marginal utility of wealth

Pirates have been intensely attacking ships off the shore of Somalia this year. Boat owners have reportedly coughed up more than $30 million in ransom and insurance premiums have shot up. If there is a sudden and unexpected increase in risk, who gains?

Warranties in the used car market ________ the problem of private information thereby causing the price of good and bad used cars to ________.

Mortgage insurance protects lenders when a borrower defaults by making up any shortfall needed to repay the loan if the sale of the property doesn't cover the debt. Federally regulated lenders must have mortgage insurance on loans where the buyer's down payment is less than 20 percent of the price. Why is this 20 percent threshold efficient for the insurance company?

-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. Both Steve and the insurance company will gain if the insurance premium is