Exam 20: Uncertainty, risk, and Private Information

You are about to have a meeting with your manager about a raise in your salary.You are going to request an increase of $5 000,but you believe the probability of success to be only 25%.You believe there is a 25% probability your boss will counter with a $3 000 raise and a 25% probability that your boss will offer a $1 000 raise.Finally,there is a 25% probability that you will receive no increase in your salary.What is the expected value of the outcome of your meeting?

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%. -In a particular insurance market,there is a decrease in the degree of risk aversion among buyers.Holding everything else constant,the equilibrium premium will _____ and the equilibrium quantity of insurance will _____.

A random variable:

If relevant events are _____,diversification will NOT reduce risk.

Which statement regarding a warranty is NOT true?

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:

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

Suppose that,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:

Amanda recently graduated from university,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:

The Baker family is faced with two possible states.In state 1,they remain healthy and incur no medical expenses.In state 2,their medical expenses will be $8 000.There is a 30% chance that state 1 will occur and a 70% chance that state 2 will occur.An insurance company offers to pay all of their medical expenses for a premium of $6 000.From the Bakers' point of view,this is a fair insurance policy.

Used-car dealers will often advertise how long they have been in business as a means of _____ their long-term _____.

Darnell pays $7 300 per year to an insurance company in return for its promise to pay part of his family's medical bills.The $7 300 is Darnell's:

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:

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 all of his money in the rain poncho company,what is his expected gain or loss?

For most families,total utility does NOT:

The problem of adverse selection:

Which factor is a limit to the ability of diversification to reduce risk?

Jill is a risk-averse expected-utility maximizer.Jack offers her the following bet: he will toss a coin and pay her $5 if it comes down heads,but if it comes down tails,Jill will have to pay him $5.Even though heads and tails are equally likely,Jill will not take the bet.

Which pair of events is likely to be positively correlated?

Domingo has 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 and be worth nothing and a 90% chance that nothing will happen to it.Domingo buys insurance guaranteeing that his house will be restored to its original condition should anything happen to it.The insurance premium is $2 000.Consequently (assuming other things remain unchanged),his future: