Exam 19: Uncertainty, Risk, and Private Information

Use the following to answer questions : -(Table: Income and Utility for Tyler) The table Income and Utility for Tyler shows the utility Tyler receives at various income levels, but she does not know what her income will be next year. There is a 40% chance her income will be $20,000, a 40% chance her income will be $30,000, and a 20% chance her income will be $40,000. What is her expected utility in utils?

Domingo has a total wealth of $500,000 composed of a house worth $100,000 and $400,000 in cash. He keeps the cash in a safe deposit box, so that it is completely safe. However, there is a 10% chance that his house will burn down by the end of the year and be worth nothing and a 90% chance that nothing will happen to it. Without insurance, the expected value of his end-of-year wealth is:

Solutions to moral hazard include:

Use the following to answer questions : -(Table: Income and Utility for Tyler) The table Income and Utility for Tyler shows the utility Tyler receives at various income levels, but she does not know what her income will be next year. There is a 40% chance her income will be $20,000, a 40% chance her income will be $30,000, and a 20% chance her income will be $40,000. What is the maximum amount of insurance Tyler would be willing to pay to guarantee an income of $28,000?

Which pair of events is likely to be positively correlated?

Use the following to answer questions : -(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty. Suppose the probability that the sitcom does not make it to television is 50%, that it makes it to television but is not the most viewed show in its time slot is 30%, and that it makes it to television and is the most viewed show in its time slot is 20%. Given this information, Norman, as a utility maximizer:

The easiest risks to reduce by diversification are those associated with positively correlated events.

Use the following to answer questions : -(Table: Income and Utility for Whitney) Look at the table Income and Utility for Whitney. Whitney's income next year is uncertain: there is a 40% probability she will make $40,000 and a 60% probability she will make $80,000. The expected value of Whitney's income is:

Use the following to answer questions Scenario: Choosing Insurance The Ramirez family owns three cars and is considering buying insurance to cover the cost of repairs. They face two possible states: in state 1 their cars need no repairs and their income available for purchasing other goods and services is $50,000; in state 2 their cars need $10,000 worth of repairs and their income available for purchasing other goods and services is reduced to $40,000. The probability of repairs is 10%, while the probability of no repairs is 90%. -(Scenario: Choosing Insurance) Refer to the information in the scenario Choosing Insurance. For $2,000 the Ramirez family can buy insurance that will cover the full cost of repairs. If family members are risk-averse and want to maximize their expected utility:

Insurance companies attempt to minimize moral hazard by imposing:

If an individual is risk-averse, then his or her total utility function must display _____ marginal utility.

Which of the following is TRUE if the insurance market is efficient?

The marginal utility of income for a risk-averse individual will be:

If an insurance company insured 100,000 cars across the state against theft, which of the following would NOT be true?

Use the following to answer questions : -(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty. Suppose the probability that the sitcom does not make it to television is 50%, that it makes it to television but is not the most viewed show in its time slot is 30%, and that it makes it to television and is the most viewed show in its time slot is 20%. Given this information, Norman's expected income is:

For most families, the marginal utility of income is:

Companies offering life insurance often require a drug test to determine whether the buyer is a smoker. A smoker must pay a higher premium. This is an example of:

Which pair of events is NOT independent?

A life insurance company will often require an applicant to submit to a brief physical exam to assess that person's basic level of health. This practice is a form of _____ to lessen the problem of _____.

If a stock analyst believes there is a 25% 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 25% probability that it will be $50, then the expected value of the stock at the end of the year is: