Exam 20: Uncertainty, Risk, and Private Information

(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty.Suppose the probability that the sitcom does not make it to television is 30%, that it makes it to television but is not the most viewed show in its time slot is 50%, and that it makes it to television and is the most viewed show in its time slot is 20%.Given this information, Norman, as a utility maximizer:

Scenario: Flood Area Suppose you own a home that is estimated to be worth $250,000.You live in a potential flood area; as a result, the probability that you will lose your home to a flood is 30%. (Scenario: Flood Area) Look at the scenario Flood Area.Suppose an insurance company offers you flood insurance.Most likely this flood insurance would require a premium payment:

(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty.Suppose that the probability that the sitcom does not make it to television is 60%, the probability that it makes it to television but is not the most viewed show in its time slot is 30%, and that the probability that it makes it to television and is the most viewed show in its time slot is 10%.Norman's expected total utility is utils.

(Table: Income and Utility for Whitney) Look at the table Income and Utility for Whitney.Whitney's income next year is uncertain: there is a 40% probability she will make $40,000 and a 60% probability she will make $80,000.What certain income leaves Whitney as well off as her uncertain income?

If there is a 25% probability that Joseph will earn $10 per hour at his job today and a 75% probability that he will earn $20 per hour today, his expected pay per hour is:

In which of the following situations is adverse selection most likely to be a problem?

(Table: Utility for Terri and Mary) Terri and Mary are two consumers, each having an income of $300.The table Utility for Terri and Mary shows the marginal utility that each consumer would receive at various levels above and below their income.Based upon this table, if each consumer were offered insurance to offset the risk of falling income, would pay a Larger premium because he is the consumer with risk aversion.

Scenario: Health Costs Alan is hoping for a healthy year, meaning that he would have zero health costs.Given his habits, there is a 40% chance that Alan will develop a health issue that will result in $50,000 in health costs.Assume these are the only two conditions that could exist for Alan in the coming year. (Scenario: Health Costs) Look at the scenario Health Costs.When Alan's probability of developing a health problem decreases, holding everything else constant, Alan's expected value of health care costs:

Most college-bound high school seniors apply for admission to several colleges of varying reputations and admission standards.Explain how this behavior is similar to diversification of assets discussed in the chapter.

Suppose a person rolls a typical six-sided die.What is the probability that the die will come up with a 1 two times in a row?

(Table: Income and Utility for Tyler) The table Income and Utility for Tyler shows the utility Tyler receives at various income levels, but she does not know what her income will be next year.There is a 40% chance her income will be $20,000, a 40% chance her income will be $30,000, and a 20% chance her income will be $40,000.What is her expected income?

The Baker family is faced with two possible states.In state 1, they remain healthy and incur no medical expenses.In state 2, their medical expenses will be $8,000.There is a 30% chance that state 1 will occur and a 70% chance that state 2 will occur.An insurance company offers to pay all of their medical expenses for a premium of $6,000.From the Bakers' point of view, this is a fair insurance policy.True Jill is a risk-averse expected-utility maximizer.Jack offers her the following bet: he will toss a coin and pay her $5 if it comes down heads, but if it comes down tails, Jill will have to pay him $5.Even though heads and tails are equally likely, Jill will not take the bet.False

Toyotas are known for their quality and durability.As a result, compared to other used car markets, adverse selection in the used Toyota market is:

Scenario: Diversification Morris is considering investing $10,000 in a sunglass company or a rain poncho company.If it is a rainy year and he invests only in the sunglass company, he expects to lose $5,000 at the end of the year.However, if it is a rainy year and he invests only in the rain poncho company, he expects to earn $10,000.If it is a sunny year and he invests only in the sunglass company, he expects to earn $10,000 at the end of the year; if he invests only in the rain poncho company, he expects to lose $5,000 in a sunny year.There is a 50% chance of a sunny year and a 50% chance of a rainy year. (Scenario: Diversification) Based on the information in the scenario Diversification, if Morris invests all of his money in the sunglass company, what is his expected gain or loss?

Scenario: Choosing Insurance The Ramirez family owns three cars and is considering buying insurance to cover the cost of repairs.They face two possible states: state 1, in which their cars need no repairs and their income available for purchasing other goods and services is equal to $50,000; and state 2, in which their cars need $10,000 worth of repairs and their income available for purchasing other goods and services is reduced to $40,000.The probability of repairs is 10%, while the probability of no repairs is 90%. (Scenario: Choosing Insurance) Refer to the information in the scenario Choosing Insurance.The Ramirez family can buy insurance that will cover the full cost of repairs for $2,000.If family Members are risk-averse and want to maximize their expected utility:

(Table: Income and Utility for Rahim) Look at the table Income and Utility for Rahim.The expected value of Rahim's income is:

Private information can cause economic inefficiency by preventing mutually beneficial transactions.False

Domingo has total wealth of $500,000 composed of a house worth $100,000 and $400,000 in cash.He keeps the cash in a safe deposit box, so that it is completely safe.However, there is a 10% chance that his house will burn down and be worth nothing (and a 90% chance that nothing will happen to it).Domingo buys insurance that guarantees that his house will be restored to its original condition should anything happen to it.The insurance premium is $2,000.Consequently (assuming other things remain unchanged), his future:

(Table: Total Utility of Income After College Expenses) The Smith family will choose to purchase insurance:

If a stock analyst believes there is a 25% probability that the stock price of Dymonatis will equal $30 at the end of the year, a 50% probability that it will equal $40, and a 25% probability that it will equal $50, then the expected value of the stock at the end of the year is: