Exam 20: Uncertainty and Information

You overhear the following in the hallway, "Everyone eventually dies, so how can a life insurance company make a profit? Isn't it a losing battle? You will always have to pay the death benefit to your clients!" You know that life insurance companies can be profitable. This is because

-Gunnar can work as a campus security officer at a guaranteed salary of $20,000 per year or as a real estate agent. If Gunnar works as a real estate agent, there is a 50 percent chance that he will earn $10,000 per year and a 50 percent chance that he will earn $30,000 per year. Based on the above table, to maximize his expected utility, Gunnar will

-Al works as a sales clerk at a department store for a fixed salary of $2,500 per month. He is offered a job as a salesperson at a car dealership in which there is a 50 percent chance that he will make $5,000 a month and a 50 percent chance that he will make only $1,000 a month. The figure above Al's utility of wealth curve: a) What is Al's expected income from the offered job? b) What is Al's expected utility from the offered job? c) Will Al accept the offer? Why or why not? d) What is the minimum fixed salary for which Al will continue to work for the department store and not accept the dealership's offer?

When would a risk averse individual not insure a risky event?

Insurance is possible and can be profitable because of

-Van, whose utility of wealth curve is shown in the above figure, owns a home that is valued at $100,000. There is a 10 percent chance that the house will be destroyed by hurricane. The value of insurance to Van is

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 per cent of the price. This can partially prevent

Expected utility is the utility that arises from expected wealth.

-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 expected utility from taking this job?

-John's utility of wealth curve is shown in the above figure. He currently has total wealth of $20,000. If there is a 50 percent chance that his $10,000 car will be stolen, then his expected wealth equals

-Andrew's utility of wealth schedule is depicted in the above table. Andrew is offered a job as a cook which pays $10,000. He is also offered a job as a server which will pay $5,000 if tips are poor and $15,000 if tips are good. There is a 50 percent chance that tips will be poor and a 50 percent chance that tips will be good. Given the nature of Andrew's job offers and his utility of wealth schedule, Andrew's expected utility from working as a cook is ________ and from working as a server is ________.

Adverse selection is created by

Pablo must choose among options A, B, and C. Option A gives him $10,000 for sure. Option B gives him $4,000 with probability 0.5 or $16,000 with probability 0.5. Option C gives him $8,000 with probability 0.5 or $12,000 with probability 0.5. If he receives diminishing marginal utility from wealth, Pablo will

Questions about employment history on a loan application are used to prevent

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be completely destroyed, would this homeowner buy insurance?

George is considering buying shares of Intel. If the company does well, he will gain $100, but if the company does poorly, he will lose $100. George is risk averse, so for George the magnitude of the pain of losing $100 will ________ the pleasure of gaining $100.

Without warranties, used car buyers can assume that all used cars are "lemons" because of

For a risk averse person, the marginal utility of wealth

-Lucy works as a college instructor for a fixed annual salary of $30,000. She is considering quitting this job and becoming a real estate broker. Lucy believes that as a realtor she has a 40 percent chance to make $60,000 per year and a 60 percent chance to make $25,000 a year. The figure above shows Lucy's total utility of wealth curve (U). Lucy will decide to ________ and she will definitely make this choice because it gives her a greater expected ________.

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. Which of the following statements is TRUE?