Exam 20: Uncertainty, Risk, and Private Information

On any particular day, the probability that it will rain is 25% and that you will be sick is 10%. The probability that both happen on the same day is:

Suppose that an individual is risk-averse. If this individual's utility function is depicted in a graph, with income measured on the horizontal axis and utils on the vertical axis, the graph will be an upward-sloping:

By offering a menu of policies with different premiums and deductibles, insurance companies can _____ their customers; for example, a low-risk customer will often buy insurance with a lower _____ but a higher _____ than a high-risk customer.

Use the following to answer questions: -(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses. The Smith family's expected income after tuition is:

Two consumers go to the insurance company to purchase life insurance. James is a smoker and a police officer who races motorcycles in his spare time. Kathy is a nonsmoker and a librarian who likes to make quilts in her spare time. The insurance company knows that both consumers are 40 years old, but the company has no information about occupations or hobbies. How does the private information in this situation set up an adverse-selection problem? How could the insurance company lessen this problem?

Use the following to answer questions: 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: in state 1 their cars need no repairs and their income available for purchasing other goods and services is $50,000; in state 2 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) Look at the scenario Choosing Insurance. The premium on a fair insurance policy for the Ramirez family will be:

Which of the following is a principle of the insurance industry?

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.

If an insurance company insured 100,000 cars across the state against theft, which of the following would NOT be true?

Use the following to answer questions: Scenario: Flood Area Suppose you own a home that is estimated to be worth $250,000. You live in a flood plain; 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. A flood may occur, causing you to lose your entire home. In this case, your expected loss resulting from the flood would be:

Which of the following is TRUE if the insurance market is efficient?

Warranties that cover the cost of a repair or replacement will:

Use the following to answer question: -(Table: Crop Income) Look at the table Crop Income. Brent is a farmer, and his income depends on the weather.A) Calculate Brent's expected income. B) Calculate Brent's expected utility.

The problem of adverse selection:

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

In an efficient allocation of risk:

Use the following to answer questions: -(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses. The premium for a fair insurance policy to pay their daughter's tuition and eliminate the uncertainty in the Smith family's income after tuition would equal:

You own a shoe store and need a new sales associate. You have a large stack of applications, but unfortunately you have no idea who is a strong salesperson and who is a weak one. What kind of problem are you facing and how can you solve it?

Amanda recently graduated from college, and she has a job offer with uncertain income: there is a 70% probability that she will make $10,000 and a 30% probability that she will make $70,000. The expected value of Amanda's income is:

_____ of insurance are often risk-averse, and _____ of insurance are interested in reducing their exposure to risk.