Exam 20: Uncertainty and Information

-Mike has the utility of wealth curve shown in the figure above. He owns a car worth $20,000, and that is his only wealth. There is a 10 percent chance that Mike will have an accident within a year. If he does have an accident, his car is worthless. a) What is Mike's expected utility? b) What is the maximum amount that Mike is willing to pay for auto insurance? c) Suppose all car owners are like Mike insofar as they have a 10 percent chance of having an accident. An insurance company agrees to pay each person who has an accident the full value of his or her car. The company's operating expenses are $1,000. What is the minimum insurance premium that the company is willing to accept? d) Will Mike buy the company's policy? Why or why not?

In an ad for insurance, the text reads "Life's an adventure, and there are plenty of perils awaiting your jewelry: a lost or broken stone, theft, accidental loss, damage, mysterious disappearance Have you thought about insurance?" How does the inclusion of accidental loss and mysterious disappearance create moral hazard?

You took a summer job as a salesperson in a shoe store with the knowledge that you will either make $2,000 or $3,500 with probabilities 0.4 and 0.6 respectively. What is your expected income for the summer job?

For a risk averse person, an increase in wealth brings ________ total utility of wealth and ________ marginal utility of wealth.

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 take a job that pays $30,000 where her current job pays her $70,000 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?

If Sally drives less carefully after buying auto insurance, she illustrates

Moral hazard results from ________ information and adverse selection results from ________ information.

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 means that the expected utility of wealth of risk averse boat owners who do NOT have insurance and sail near Somalia is

In an ad for insurance, the text reads "Life's an adventure, and there are plenty of perils awaiting your jewelry: a lost or broken stone, theft, accidental loss, damage, mysterious disappearance Have you thought about insurance?" What is the economic reasoning for an individual to buy insurance?

If Ben becomes less likely to buy smoke detectors after he has fire insurance, he is illustrating

Many residents of the city of Adelphia drive without automobile insurance. Assuming that Adelphia is just like any other city and these are risk averse individuals, which of the following is most likely TRUE?

-Andrew's utility of wealth schedule is given 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. The expected income from the job as a cook is ________ and from the job as a server is ________.

The tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party is known as

"People buy insurance do protect themselves from moral hazard." True or false? Explain.

Goldie is indifferent between option A, which gives her $9,000 for sure, and option B, which gives her $3,000 with probability 1/3 or $18,000 with probability 2/3. Goldie's cost of risk for option B is

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 $15,000 each. Suppose 10 out of 100 boats are attacked by pirates and these 10 file claims with their insurance. Has the insurance company earned an economic profit?

-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. If Steve buys the insurance for $1,000, his expected wealth will be ________, and his expected utility will be ________ than with no insurance.

-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 entirely destroyed, what is the person's expected wealth?

-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 minimum cost of insurance in this case is

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000 and there is a 10 percent chance of losing it all. John is