Question 1

A risk-neutral decision maker will always choose the alternative with the lowest variance among alternatives with identical expected utilities.

Accepted Answer

A) True 
 B)False

Question 2

An insurance company that sells fairly-priced insurance policies to a large number of individuals with similar realized accident risk probabilities should expect to:

Accepted Answer

A) break even. 
B) lose money. 
C) make a profit. 
D) sell policies to individuals with all types of risk preference. 
A) break even. 
B) lose money. 
C) make a profit. 
D) sell policies to individuals with all types of risk preference.

Question 3

Suppose a decision maker has a utility function $$U = \sqrt { I }$$ and is faced with a lottery where there is a 30% chance of earning $30 and a 70% chance of earning $80. What is the expected utility of this lottery?

Accepted Answer

A) 7.6 
B) 7.9 
C) 8.2 
D) 8.5 
A) 7.6 
B) 7.9 
C) 8.2 
D) 8.5

Question 4

Heading: Analyzing Risky Decisions
**Reference: Use the decision tree along with the given probabilities to answer the next six questions 
Probability Event A = 30% Probability Event B = 70%
Probability Event 1 = 58% Probability Event 2 = 42%
Probability of Event A given that Event 1 occurs = 16%
Probability of Event B given that Event 1 occurs = 84%
Probability of Event A given that Event 2 occurs = 50%
Probability of Event B given that Event 2 occurs = 50%
  
-A decision tree is:

Accepted Answer

A) a diagram that describes the options available to a decision marker as well as the certain events that can occur at each point in time. 
B) a diagram that helps the observer calculate the expected value, variance and standard deviation of a probability distribution. 
C) not applicable to making decisions under conditions of uncertainty. 
D) a diagram that describes the options available to a decision marker as well as the risky events that can occur at each point in time. 
A) a diagram that describes the options available to a decision marker as well as the certain events that can occur at each point in time. 
B) a diagram that helps the observer calculate the expected value, variance and standard deviation of a probability distribution. 
C) not applicable to making decisions under conditions of uncertainty. 
D) a diagram that describes the options available to a decision marker as well as the risky events that can occur at each point in time.

Question 5

The expected utility of a lottery is the expected value of the utility levels that the decision maker receives from the payoffs in the lottery.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following statements is correct for a decision maker facing a choice between a sure thing and a lottery when the sure thing has the expected payoff of the lottery?

Accepted Answer

A) Risk-loving decision makers will require a positive risk premium to bear risk. 
B) Risk-neutral decision makers will require a positive risk premium to bear risk. 
C) Risk-averse decision makers will require a positive risk premium to bear risk. 
D) The risk premium depends on the characteristics of the lottery, not on the characteristics of the utility function of the decision maker. 
A) Risk-loving decision makers will require a positive risk premium to bear risk. 
B) Risk-neutral decision makers will require a positive risk premium to bear risk. 
C) Risk-averse decision makers will require a positive risk premium to bear risk. 
D) The risk premium depends on the characteristics of the lottery, not on the characteristics of the utility function of the decision maker.

Question 7

The sum of the probabilities of all possible outcomes must equal exactly one.

Accepted Answer

A) True 
 B)False

Question 8

A risk-loving decision maker will choose the alternative with the highest variance among alternatives with identical expected utilities.

Accepted Answer

A) True 
 B)False

Question 9

Consider four lotteries, A, B, C, and D, all with an expected value of $100. The associated standard deviations of the lotteries are: A is 10, B is 15, C is 5, and D is 20. Which lottery is the riskiest?

Accepted Answer

A) Lottery A 
B) Lottery B 
C) Lottery C 
D) Lottery D 
A) Lottery A 
B) Lottery B 
C) Lottery C 
D) Lottery D

Question 10

A risk premium, RP, can be computed with the following formula, where I1 and I2 are the two payoffs to a lottery, with probabilities p and (1-p), respectively:

Accepted Answer

A)  $p \left( I _ { 1 } \right) + ( 1 - p ) I _ { 2 } = R P$ 
B)  $p U \left( I _ { 1 } \right) + ( 1 - p ) U \left( I _ { 2 } \right) = R P$ 
C)  $p U \left( I _ { 1 } \right) + ( 1 - p ) U \left( I _ { 2 } \right) = U ( E V - R P )$ 
D)  $U ( E V ) = R P$ 
A)  $p \left( I _ { 1 } \right) + ( 1 - p ) I _ { 2 } = R P$ 
B)  $p U \left( I _ { 1 } \right) + ( 1 - p ) U \left( I _ { 2 } \right) = R P$ 
C)  $p U \left( I _ { 1 } \right) + ( 1 - p ) U \left( I _ { 2 } \right) = U ( E V - R P )$ 
D)  $U ( E V ) = R P$

Question 11

Lotteries A and B have the same expected value, but B has larger variance. Which of the following statements is true, all else equal?

Accepted Answer

A) If the decision maker is risk averse, lottery A will have the larger risk premium. 
B) If the decision maker is risk neutral, lottery B will have the larger risk premium. 
C) If the decision maker is risk loving, both lotteries will have a positive risk premium. 
D) If the decision maker is risk averse, lottery B will have the larger risk premium. 
A) If the decision maker is risk averse, lottery A will have the larger risk premium. 
B) If the decision maker is risk neutral, lottery B will have the larger risk premium. 
C) If the decision maker is risk loving, both lotteries will have a positive risk premium. 
D) If the decision maker is risk averse, lottery B will have the larger risk premium.

A risk-neutral decision maker will always choose the alternative with the lowest variance among alternatives with identical expected utilities.

An insurance company that sells fairly-priced insurance policies to a large number of individuals with similar realized accident risk probabilities should expect to:

Suppose a decision maker has a utility function $U = \sqrt { I }$ and is faced with a lottery where there is a 30% chance of earning $30 and a 70% chance of earning $80. What is the expected utility of this lottery?

The expected utility of a lottery is the expected value of the utility levels that the decision maker receives from the payoffs in the lottery.

Which of the following statements is correct for a decision maker facing a choice between a sure thing and a lottery when the sure thing has the expected payoff of the lottery?

The sum of the probabilities of all possible outcomes must equal exactly one.

A risk-loving decision maker will choose the alternative with the highest variance among alternatives with identical expected utilities.

Consider four lotteries, A, B, C, and D, all with an expected value of $100. The associated standard deviations of the lotteries are: A is 10, B is 15, C is 5, and D is 20. Which lottery is the riskiest?

A risk premium, RP, can be computed with the following formula, where I1 and I2 are the two payoffs to a lottery, with probabilities p and (1-p), respectively:

Lotteries A and B have the same expected value, but B has larger variance. Which of the following statements is true, all else equal?

Analyzing Economic Problems

Demand and Supply Analysis

Consumer Preferences and the Concept of Utility

Consumer Choice

The Theory of Demand

Inputs and Production Functions

Costs and Cost Minimization

Cost Curves

Perfectly Competitive Markets

Competitive Markets: Applications

Monopoly and Monopsony

Capturing Surplus

Market Structure and Competition

Game Theory and Strategic Behavior

General Equilibrium Theory

Externalities and Public Goods

Filters

Exam 15: Risk and Information

A risk-neutral decision maker will always choose the alternative with the lowest variance among alternatives with identical expected utilities.

An insurance company that sells fairly-priced insurance policies to a large number of individuals with similar realized accident risk probabilities should expect to:

Suppose a decision maker has a utility function U=IU = \sqrt { I }U=I​ and is faced with a lottery where there is a 30% chance of earning $30 and a 70% chance of earning $80. What is the expected utility of this lottery?

The expected utility of a lottery is the expected value of the utility levels that the decision maker receives from the payoffs in the lottery.

Which of the following statements is correct for a decision maker facing a choice between a sure thing and a lottery when the sure thing has the expected payoff of the lottery?

The sum of the probabilities of all possible outcomes must equal exactly one.

A risk-loving decision maker will choose the alternative with the highest variance among alternatives with identical expected utilities.

Consider four lotteries, A, B, C, and D, all with an expected value of $100. The associated standard deviations of the lotteries are: A is 10, B is 15, C is 5, and D is 20. Which lottery is the riskiest?

A risk premium, RP, can be computed with the following formula, where I1 and I2 are the two payoffs to a lottery, with probabilities p and (1-p), respectively:

Lotteries A and B have the same expected value, but B has larger variance. Which of the following statements is true, all else equal?

Analyzing Economic Problems

Demand and Supply Analysis

Consumer Preferences and the Concept of Utility

Consumer Choice

The Theory of Demand

Inputs and Production Functions

Costs and Cost Minimization

Cost Curves

Perfectly Competitive Markets

Competitive Markets: Applications

Monopoly and Monopsony

Capturing Surplus

Market Structure and Competition

Game Theory and Strategic Behavior

General Equilibrium Theory

Externalities and Public Goods

Filters

Suppose a decision maker has a utility function $U = \sqrt { I }$ and is faced with a lottery where there is a 30% chance of earning $30 and a 70% chance of earning $80. What is the expected utility of this lottery?