Exam 20: Uncertainty, Risk, and Private Information

A friend of yours owes you $10, and he wants to flip a coin for double or nothing.If the coin lands heads, he will pay you $20.If the coin lands tails up, he will pay you nothing.As the coin is in midair, what is your expected value of this wager?

(Table: Amy's Utility Function) Look at the table Choosing Insurance.Amy is an entrepreneur with current income equal to $40,000.Amy is considering development of a new product.The probability that her new product earns Amy $10,000 in additional income is 0.5, and the probability that Amy incurs a reduction of $10,000 from her current income is also 0.5.Suppose Amy can buy a fair insurance policy that will compensate her for any losses.Amy's premium will be ________, her guaranteed income will be , and her expected utility Will be 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.The expected value of Whitney's income is:

(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty.Assume 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 the probability that it makes it to television and is the most viewed show in its time slot is 10%.Norman's expected income is:

A fair insurance policy is one in which the premium equals the expected value of the claim.False

An individual finds that as his income increases, his total utility also increases but at a decreasing rate.This can be attributed to:

(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 the maximum amount of insurance Tyler would be willing to pay to guarantee an income of $28,000?

Moral hazard occurs only when people fail to do what is in their best interest.True

When some people know things that other people don't know, there is ; it can ________ economic decisions.

(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses.Mr.and Mrs.Smith would be willing to pay as much as for insurance to pay their daughter's tuition and eliminate the uncertainty in the family's income after tuition.

Insurance companies deal with the problems created by moral hazard by:

An individual can almost eliminate risk by taking a small share in many independent events or by taking advantage of the predictability associated with large numbers of independent events.This is known as:

(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 utility?

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 $1,000.If family members are risk-averse and want to maximize their expected utility:

You are considering the purchase of a $10 ticket for a raffle with a grand prize of $1,000 (assume you are risk neutral).There are two prizes worth $100 and five prizes worth $20.If you know that only 100 tickets will be sold, what is the expected value of your net winnings? Should you purchase the ticket?

You are considering the purchase of one ticket for a raffle with a grand prize of $1,000.There are two prizes worth $100 and five prizes worth $20.If you know that only 100 tickets will be sold, what is the most you would pay for one raffle ticket?

A insurance policy is an insurance policy for which the premium is equal to the expected value of the claim.

(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses.The Smith family experiences marginal utility as income Increases.The marginal utility of income between $32,500 and $35,000 is utils per Dollar, while it is utils per dollar between $45,000 and $47,500.

(Table: Natasha's Total Utility) Look at the table Natasha's Total Utility.Natasha earns $50,000 per year but faces losing $20,000 of it if she is late with her work.If there is a 25% probability that Natasha will be late with her work and her income will equal $30,000, what certain income leaves Natasha just as well off as her uncertain income?

In a particular insurance market, there is a decrease in the degree of risk aversion among buyers.Holding everything else constant, the equilibrium premium will and the equilibrium quantity of insurance will _.