Exam 17: Uncertainty and Asymmetric Information

Jim used to be very careful with his car. However, once he bought full auto insurance on it, he stopped turning on his alarm or even locking it when parking it. This is an example of adverse selection.

Most of the interest in using incentives arises due to uncertainty.

If ________ enters into an exchange with another party who has ________ information, there is asymmetric information and adverse selection.

A person who is willing to take a bet with a negative expected value is risk-loving.

An example of mechanism design is

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. What is the expected value of the game?

Adverse selection is a situation in which asymmetric information results in low-quality goods or low-quality consumers being squeezed out of transactions because they are unable to demonstrate their quality.

You cause a fire insurance company to face a moral hazard problem when you take ________ you buy fire insurance from the company.

Consider the following game. You pick a card from a deck and each time you select an ace, you get $260. For all other cards you must pay $13. What is the expected value of the game?

A credit union faces a(n) ________ problem when it lends funds to a customer to remodel her home and the customer then opportunistically uses the funds for a gambling trip to Las Vegas.

Relating to the Economics in Practice on page 356: Huntington's disease is an inheritable disorder which affects 1 in 10,000 individuals, and since 1993 there has been a test that perfectly predicts the disease. Presently, insurance companies are not legally allowed to inquire about the results of genetic tests. This has led to ________ favoring potential insurance buyers.

As a result, of adverse selection problems in the fire insurance market, it is likely that over time

Expected value and expected utility are synonyms.

Moral hazard occurs when buyers and sellers take actions to communicate quality in a world of uncertainty.

Because education is less costly to obtain for highly productive individuals who are also likely to be highly productive in the work place, education ________ in the job market.

You are in the market for a used 2013 Toyota Corolla. You know that half of the 2013 Corollas are lemons and half are peaches. If you could be assured that the Corolla you were buying was a peach, you would be willing to pay up to $12,000. On the other hand, you would only be willing to pay $4,000 for a lemon. You have no ability to discern whether any particular Corolla is a lemon or a peach. Sellers of Corollas, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $3,000 or more and peach sellers will be willing to sell their cars for $9,000 or more. Over time the price in the market for 2013 Corollas will

Refer to the data provided in Table 17.5 below to answer the following question(s). The table shows the relationship between income and utility for Lucy. Table 17.5 -Refer to Table 17.5. Lucy earns $20,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Lucy takes the bet, she will pick the Packers. She believes that the Packers have a 50-50 chance of winning the game. If the Packers win, then Lucy will win $38,000. However, if they lose she loses her entire salary ($0). Will Lucy take the bet?

Moral hazard is a situation in which asymmetric information results in high-quality goods or high-quality consumers being squeezed out of transactions because they are unable to demonstrate their quality.

Refer to the information provided in Figure 17.1 below to answer the question(s) that follow. Figure 17.1 -Refer to Figure 17.1. Dmitri has two job offers when he graduates from college. Dmitri views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $40,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $40,000. Dmitri believes that he has a 50-50 chance of earning the bonus. Dmitri's expected utility from the first job offer is ________ and it is ________ from the second job offer.

Refer to the data provided in Table 17.5 below to answer the following question(s). The table shows the relationship between income and utility for Lucy. Table 17.5 -Refer to Table 17.5. Lucy earns $20,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Lucy takes the bet, she will pick the Packers. She believes that the Packers have a 50-50 chance of winning the game. If the Packers win, Lucy will double her money ($40,000) but if they lose she loses her entire salary ($0). This bet can be characterized as