Exam 19: Uncertainty, Risk, and Private Information

Bikul has just started a great job and plans to buy a fancy car worth $100,000. Bikul is risk-averse in money matters, but he likes to drive fast, so the probability that he wrecks the car (a total loss of $100,000) is 0.10. The probability that he has no accidents is 0.90. If an insurance company offers Bikul a fair insurance policy, the premium will be:

If there is a 25% probability that Joseph will earn $10 per hour at his job today and a 75% probability that he will earn $20 per hour today, his expected pay per hour is:

Mary and Bob are trying to decide how much auto insurance to buy. They share the same expectations of an accident, with the same dollar loss. They also have the same income levels. However, Mary would rather buy very little insurance, while Bob would rather buy much more insurance. This suggests that:

The strategy of reducing or eliminating risks by taking a small share in many independent events or by taking advantage of the predictability associated with large numbers of independent events is known as:

Suppose for the coming year a family has calculated its expected value for car repairs to be $3,000. The family decides to buy a car insurance policy that would cover such claims. This insurance policy would cost a total of $3,000 for the household. This insurance policy is:

The total amount of funds that potentially could be paid out by an insurance company is:

Amanda recently graduated from college, and she has a job offer with uncertain income. There is a 70% probability that she will make $10,000 and a 30% probability that she will make $70,000. Suppose Amanda is offered another job with a certain income. All else equal, if she has a constant marginal utility of income, she will accept the second job offer only if it pays more than:

Use the following to answer questions Scenario: Used Car Market In the used car market, cars of poor quality are called lemons, while cars of good quality are plums. Suppose the probability of obtaining a lemon is 60% and the probability of obtaining a plum is 40%. Also assume a plum is worth $15,000 and a lemon is worth $3,000. -(Scenario: Used Car Market) Look at the scenario Used Car Market. The expected value of a used car is:

Private information leads _____ to expect hidden problems in items offered for sale, leading to _____ prices and to the best items being kept off the market.

When Lloyd's of London offered to provide insurance to merchant ships in the eighteenth century, Lloyd's was:

Insurance companies deal with the problems of moral hazard by:

The premium for a(n) _____ insurance policy is equal to the expected value of the claim.

Suppose a person rolls a typical six-sided die. What is the probability that the die will come up with a 1 two times in a row?

Use the following to answer questions Figure: Risk Aversion -(Figure: Risk Aversion) Look at the figure Risk Aversion. Bob and Nancy have the same income and the same total utility. Nancy is _____ risk-averse than Bob because her marginal utility curve is _____ than Bob's.

The existence of a large and growing gambling industry clearly shows that many people are risk-loving.

Use the following to answer questions : -(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses. The Smith family has _____ marginal utility as income increases. The marginal utility of income between $32,500 and $35,000 is _____ utils per dollar, while it is _____ utils per dollar between $45,000 and $47,500.

Use the following to answer questions Scenario: Diversification Morris is considering investing $10,000 in a sunglass company or a rain poncho company. If it is a rainy year and he invests only in the sunglass company, he will lose $5,000. However, if it is a rainy year and he invests only in the rain poncho company, he will earn $10,000. If it is a sunny year and he invests only in the sunglass company, he will earn $10,000; if he invests only in the rain poncho company, he will lose $5,000 in a sunny year. There is a 50% chance of a sunny year and a 50% chance of a rainy year. -(Scenario: Diversification) Look at the scenario Diversification. If Morris invests all of his money in the sunglass company, what is his expected gain or loss?

If a stock analyst believes there is a 10% probability that the stock price of Dymonatis will be $30 at the end of the year, a 50% probability that it will be $40, and a 40% probability that it will be $50, then the expected value of the stock at the end of the year is:

If there is a 50% probability that Joseph will earn $10 per hour at his job today and a 50% probability that he will earn $20 per hour today, his expected pay per hour is:

A person who has a constant marginal utility of income will be risk-averse.