Exam 20: Uncertainty and Information

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. The value of insurance to Andrew against an accident is

Ashwini is thinking of buying travel insurance (which pays her if she needs to cancel her trip) for her trip to Cancun over spring break. There is a 5 percent chance that she will need to cancel her trip. Without insurance she would lose the full $2,000 price of the trip; with insurance she would get a full refund of $2,000. The premium for this insurance is $105. Which of the following is CORRECT? I. The expected value of Ashwini's loss is $100. II) If Ashwini is risk averse she is willing to buy the insurance only if its price is less than $100.

Adverse selection is the tendency for people who accept contracts to be those who

Which of the following is an example of moral hazard?

Katy has an ailing and wealthy, but miserly, parent. The parent has told Katy that if she takes care of him until he dies, then she will get $100,000 in inheritance. Katy knows that there is only a 50-50 chance that her father will leave her the full amount or nothing. To take care of her father, she has to quit her job that pays $60,000 where per year. If her father is expected to pass away in 1 year, what is Katy's expected wealth if she takes care of her father?

In the market for automobile insurance, adverse selection implies that

For a risk-averse individual, as wealth increases, total utility ________ and marginal utility ________.

-Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. Her utility of wealth curve is shown in the figure above. What's Adriana's cost of risk?

-Jimmy's utility of wealth schedule is given in the table above. Jimmy has a job with a one-third chance of earning $200 and a two-thirds chance of earnings $400. Jimmy's cost of risk is

Because Don has health insurance, he is more likely to see the doctor when he has a cold. This is an example of

Moral hazard occurs ________ an agreement is made and when monitoring the parties to the agreement is ________.

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. What is Nara's expected wealth if she places her money in the stock market?

Life insurance companies often give applicants a physical examination to prevent

-Marylou, whose utility of wealth curve is shown in the figure above, faces two options. Option A yields $200 for sure. Option B has a 0.3 probability of yielding $100, and a 0.7 probability of yielding $300. Marylou, who is

Hostess Brands is selling off its assets after liquidation. A potential buyer for the Twinkies brand has found that the total revenue will be $3 billion a year if the brand is managed well and $1 billion a year if the brand is managed poorly. There is .6 (or 60 percent) chance of managing the brand well and a .4 (or 40 percent) chance of managing the brand poorly. What is the expected total revenue?

-Van, whose utility of wealth curve is shown in the above figure, owns a home that is valued at $100,000. Initially there is a 10 percent chance that the house will be destroyed by hurricane. As the risk of destruction due to hurricane rises from 10 percent to 20 percent, the minimum cost of insurance

An increase in Meta's wealth from $3,000 to $6,000 raises her utility from 80 units to 100 units. If she is risk averse, with a wealth of $9,000 her utility might be

Suppose there are only two kind of cars in the market for used cars: lemons and good cars. A lemon is worth $1,000 both to its current owner and to anyone who buys it. A good car is worth $8,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car, and there is no warranty. What is the prevailing price of a used car?

Explain the concept of moral hazard. Give an example.

Stan, who is risk averse, can invest in project A or project B. Project A returns $3,000 with probability 1/2 and $9,000 with probability 1/2. Project B returns nothing with probability 1/2 and $12,000 with probability 1/2. For Stan, project A has