Exam 20: Uncertainty and Information

-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. With no insurance, Steve's expected utility is

In the health insurance market, moral hazard occurs when

Moral hazard exists chiefly because of

Pedro's utility of wealth is 6 units for $10,000 and 10 units for $20,000. A friend gave him a lottery ticket for his birthday. The ticket won, giving him either $10,000 with probability 0.5 or $20,000 with probability 0.5. Pedro's expected utility from the lottery ticket is

Buying insurance is similar to

Jason is a Web page designer. He estimates that this summer, he has a 0.6 probability of making $10,000 and a 0.4 probability of making only $2,000. What is Jason's expected income this summer?

Used car buyers believe a car is good quality when the seller signals the car's quality by offering a warranty because

-Bobby is offered a job as a salesperson in which there is a 50 percent chance that he will make $2,000 and a 50 percent chance that he will make $10,000. Bobby's utility of wealth curve is shown in the figure above. What is Bobby's expected utility from taking this job?

In the market for automobile insurance, moral hazard implies that

Bill purchases property insurance for his office building, which includes coverage for fire damage. The policy offers premium discounts for smoke detectors, fire alarms, fire extinguishers and sprinkler systems. This is an incentive system to help avoid

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. To give Nara the maximum expected wealth, what should she do?

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?

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. The pirate activity and increase in premiums means that the expected wealth of boat owners who sail near Somalia is

In the health insurance market, adverse selection occurs when

Kedran is indifferent between option A, which gives her $10,000 for sure, and option B, which gives her $5,000 with probability 0.4 or $15,000 with probability 0.6. Kedran's cost of risk for option B is

The slope of the utility of wealth curve of a risk-averse person

-Bobby is offered a job as a salesperson in which there is a 50 percent chance that he will make $2,000 and a 50 percent chance that he will make $10,000. Bobby's utility of wealth curve is shown in the figure above. What is Bobby's cost of risk?

If a life insurance company offers coverage regardless of age, health status, or smoking history, it is likely to suffer

The International Maritime Bureau said the waters off Somalia are the world's most dangerous, accounting for nearly a third reported pirate attacks worldwide. Suppose all boats are insured to $100,000 and pay a premium of $10,000 each. Suppose 10 out of 100 boats are attacked by pirates and these 10 file claims with their insurance. What is the value of the claims?

The cost of risk is the same for everyone.