Exam 17: Uncertainty and Asymmetric Information

Mark has two job offers when he graduates from college. Mark views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $50,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $60,000. Mark believes that he has a 50-50 chance of earning the bonus. If Mark takes the offer that maximizes his expected utility and is risk neutral, which job offer will he choose?

Relating to the Economics in Practice on page 360: An individual with a parent who has Huntington's disease has a 50 percent chance of also having the disease, and can use this information when deciding on the purchase of health insurance. This is an example of ________ favoring potential insurance buyers.

Refer to the Economics in Practice on page 361. Advertisements provide information in two ways-what they say and what they omit.

You are in the market for a used 2006 Honda Accord. You know that half of the 2006 Accords are lemons and half are peaches. If you could be assured that the Accord you were buying was a peach, you would be willing to pay up to $10,000. On the other hand, you would only be willing to pay $2,000 for a lemon. You have no ability to discern whether any particular Accord is a lemon or a peach. Sellers of Accords, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $1,500 or more and peach sellers will be willing to sell their cars for $8,500 or more. You are willing to offer ________ for a car of unknown quality and ________ are willing to sell you their car.

Life insurance companies require that prospective policy holders have a medical check‐up before the companies will sell the policy because of a(n) ________ problem in which the insured could be ________ than expected.

Mechanism design is used to

Refer to the data provided in Table 17.1 below to answer the following questions. The table shows the relationship between income and utility for Jane. Table 17.1 Income Total Utility \ 0 0 \ 20,000 25 \ 40,000 45 \ 60,000 60 \ 80,000 70 -Refer to Table 17.1. Suppose Jane has a 1/3 chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Jane does not become disabled, she will earn her usual salary of $60,000. Jane has the opportunity to purchase disability insurance which will pay her her full salary in the event she becomes disabled. How much would such an insurance policy be worth to Jane?

Mechanism design can be used to provide employers and employees with the right incentives in labor markets.

In the area of market signaling, education is a strong signal in the job market because

Annie, a high school student, baby sits to earn extra cash. In order to differentiate herself from other baby sitters, Annie took a babysitting course from the Red Cross. This is an example of a market signal.

Consider the following game. You roll a six-sided die and each time you roll a 6, you get $30. For all other outcomes you pay $6. What is the expected value of the game?

The insurance industry is susceptible to adverse selection problems, but not problems of moral hazard.

Universal health coverage, lemon laws, and dealer warranties are all examples of tools used to reduce

Consider the following game. You pick a card from a deck and each time you select an ace, you get $260. For all other cards you must pay $13. This game is a fair bet.

A diagram of an individual's utility from income will be a line with an increasing slope if the individual is risk averse.

Relating to the Economics in Practice on page 363: The smart phone app which allows skiers at a slope to report weather conditions to others would lessen the problem of

Refer to the data provided in Table 17.3 below to answer the following questions. The table shows the relationship between income and utility for Terri. Table 17.3 Income Total Utility \ 0 0 \ 20,000 10 \ 40,000 25 \ 60,000 45 \ 80,000 75 -Refer to Table 17.3. Suppose Terri has a 25% chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Terri does not become disabled, she will earn her usual salary of $80,000. Terri has the opportunity to purchase disability insurance for $20,000 which will pay her her full salary in the event she becomes disabled. Would Terri purchase such a policy?

Moral hazard occurs when one party to a contract changes his behavior in response to that contract and thus passes on costs of that behavior to the other party.

Refer to the data provided in Table 17.3 below to answer the following questions. The table shows the relationship between income and utility for Terri. Table 17.3 Income Total Utility \ 0 0 \ 20,000 10 \ 40,000 25 \ 60,000 45 \ 80,000 75 -Refer to Table 17.3. Suppose Terri has a 25% chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Terri does not become disabled, she will earn her usual salary of $80,000. Terri has the opportunity to purchase disability insurance which will pay her her full salary in the event she becomes disabled. How much would such an insurance policy be worth to Terri?

Adverse selection and moral hazard are examples of