Exam 20: 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:

Risk-averse individuals are willing to make deals that reduce their income to reduce their risk.

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)Use Scenario: Choosing Insurance.For $900,the Ramirez family can buy insurance that will cover the full cost of repairs.If family members are risk-averse and maximize their expected utility,they will:

Which strategy is NOT used for dealing with adverse selection in the labour market?

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)Use Scenario: Diversification.If Morris invests half of his money in the sunglass company and half in the rain poncho company,he will earn _____ in a sunny year and _____ in a rainy year.

Micah is considering turning pro before his graduating year basketball season.If he turns pro,Micah expects a pro contract worth $2 million in present value.If he does not turn pro,there is a 50% chance an injury will prevent him from playing professionally and a 50% chance he will get a pro contract worth $4 million in present value.What is the expected present value of Micah's pro contract if he stays in university for his graduating year?

When an individual knows more about his or her own actions than other people do,incentives are distorted,which causes:

Sellers of used cars may have private information to which buyers are not privy.This knowledge of private information does NOT lead to:

Use the following to answer questions : Scenario: Flood Area Suppose that you own a home that is estimated to be worth $250 000.You live in a flood plain;as a result,the probability that you will lose your home to a flood is 30%. -As a result of frequent flooding,the insurance market has noted a positive correlation between flooding and the amount of insurance monies paid out for such floods.Holding demand for insurance constant,if flooding is expected to continue to be a problem,flood insurance premiums will MOST likely:

When some people know things that other people don't know,there is _____;it can _____ economic decisions.

Why might the supply curve of insurance policies shift to the right?

Organized-gambling venues such as those at Las Vegas tend to attract:

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

If those who are most willing to bear risk end up bearing it,then we say that the insurance market is:

Solutions to moral hazard include:

A friend of yours owes you $10,and he wants to flip a coin for double or nothing.If the coin lands heads,he will pay you $20.If the coin lands tails up,he will pay you nothing.As the coin is in midair,what is your expected value of this wager?

The strategy of investing in several assets so that any possible losses are independent events is:

Use the following to answer questions : Scenario: Flood Area Suppose that you own a home that is estimated to be worth $250 000.You live in a flood plain;as a result,the probability that you will lose your home to a flood is 30%. -(Scenario: Flood Area)Use Scenario: Flood Area.Suppose that an insurance company offers you flood insurance.MOST likely,this insurance would require a premium payment:

Suppose that 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?

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.