Deck 6: The Economics of Information and Choice Under Uncertainty

Question 1

The extensive sunk costs of heavily advertised products suggest a reason for believing that those products will

A)turn out to have higher quality than unadvertised products.
B)turn out to have lower quality than unadvertised products.
C)cause consumers to question their intrinsic value.
D)be hard to sell to the consumer without heavy persuasion.

Answer 1

A

Question 2

For the average person, insurance is

A)a fair gamble.
B)an unfair gamble.
C)not a gamble.
D)useless option.

Answer 2

B

Question 3

In general, a firm sends a signal to consumers that their product is high quality when

A)it has high level of fixed costs.
B)it has low level fixed costs.
C)it spends very little in advertising campaigns.
D)it gives huge discounts to large sellers.

Answer 3

A

Question 4

The "Lemon's" argument helps to explain why

A)physical depreciation is the only reason for the sharp price differential between new and used cars.
B)physical depreciation is an insufficient reason for the sharp price differential between new and used cars.
C)used cars fail to satisfy consumer demands for transportation.
D)new and used cars sell for more than their intrinsic value would suggest.

Question 5

Competitive pressure in the insurance market will, in general,

A)make insurance premiums unattractive to drivers who are much riskier than average.
B)make insurance premiums attractive to low risk drivers.
C)induce risky drivers to self-insure.
D)induce the least risky drivers to self-insure.

Question 6

A person's incentive to spend additional money on conspicuous consumption goods will be _______________ to the amount and reliability of independent information that people have about his abilities.

A)unrelated
B)positively related
C)inversely related
D)equal

Question 7

A gamble in which you win D dollars if the coin comes up heads, but lose D dollars if the coin comes up tails has an expected value of

A) 1/2D.
B) -1/2D.
C) D.
D) 0.

Question 8

The utility function of wealth for a risk-seeker has

A)an increasing slope as wealth rises.
B)a decreasing slope as wealth rises.
C)a constant slope as wealth rises.
D)a slope that could be any of these since utility of wealth is unrelated to risk-seeking.

Question 9

Conspicuous consumption as an ability signal

A)completely different from a prisoner's dilemma.
B)is more effective if the positional goods nature of consumption causes everyone to consume elaborately.
C)will likely continue even if it is wasteful for all involved.
D)characterized by lower levels of consumption.

Question 10

In insurance markets, adverse selection often

A)creates exchange possibilities that are beneficial to consumers and insurance companies.
B)creates an abundance of lawsuits.
C)brings down prices for insurance premiums.
D)eliminates exchange possibilities that would be beneficial to both consumers and insurance companies alike.

Question 11

The general message of the full disclosure principle is that

A)information is costly to fake.
B)producers should offer lifetime warranties for low quality products.
C)the lack of evidence that something resides in a favored category will often suggest that it belongs to a less favored one.
D)information is symmetric.

Question 12

Which of the following gambles should be considered more attractive?

A)If heads, you win $200; if tails, you lose $198.
B)If heads, you win $5; if tails, you lose $10.
C)If heads, you win $6; if tails, you lose $4.
D)If heads, you win $9; if tails, you lose $6.

Question 13

When a job applicant discloses information that could be seen as favorable by potential employers, other job candidates

A)must do the same in order to get hired.
B)will be seen as more unfavorable by potential employers.
C)will earn less compensation.
D)will be seen as more favorable by potential employers.

Question 14

Persons whose utility functions are concave with respect to wealth are said to be

A)risk-seekers.
B)risk-neutral.
C)risk-averse.
D)fair gamblers.

Question 15

Where important decisions involving people we do not know well are involved,

A)even weak signals of ability are often decisive.
B)weak signals of ability are never decisive.
C)we are more likely to be risk neutral.
D)we are less likely to self-insure.

Question 16

A risk-neutral consumer

A)will always refuse a fair gamble.
B)will always accept a fair gamble.
C)is indifferent between accepting and refusing a fair gamble.
D)avoids all risks.

Question 17

When the size of the potential loss is small, most people will

A)insure because insurance costs less than the expected loss.
B)self-insure because they can afford it and the expected loss less than the insurance premium.
C)self-insure because the expected loss cannot be calculated.
D)self-insure because insurance companies do not like to insure for small losses.

Question 18

Assuming there is no pleasure in the gambling process, a risk-averse person with perfect information will

A)always refuse a fair gamble.
B)consider all gambles unfair.
C)always accept a fair gamble.
D)sometimes refuse a fair gamble.

Question 19

For a signal between two adversaries to be credible, it must

A)be verified by a third party.
B)be costly to fake or duplicate.
C)be part of a sequence of transactions.
D)have both a good news-bad news component.

Question 20

Adverse selection is the process by which

A)"undesirable" members of a particular market are more likely to participate in exchange.
B)"undesirable" members of a particular market are less likely to participate in exchange.
C)adversaries communicate negative messages.
D)full-disclosure becomes impossible.

Question 21

You are given the following gamble: behind one door is $500; behind another is $100; behind another is $0. What is the expected value of the gamble?

A)$600
B)$200
C)$300
D)We need more information in order to answer

Question 22

(Appendix) The winner in an auction bidding process will

A)get less value than was paid in the bidding.
B)get more value than was paid in the bidding.
C)on average pay an amount equal to the product's true value.
D)win the bid if he takes the average of his best estimate of the starting bid and the items true value.

Question 23

One thousand tickets are sold at $1 each for a color television valued at $350. What is the expected value of the gain if a person purchases one ticket?

A)-$349
B)-$0.65
C)-$0.001
D)-$0.80

Question 24

Your utility function is given by U = M1/2. You have a choice: take $100 in cash or flip a coin. If you flip a coin, the outcomes are as follows: heads, you win $225; tails, you win $49. You will

A)take the $100 in cash.
B)take the gamble.
C)be indifferent between the cash and the gamble.
D)it is impossible to say with the information given.

Question 25

Consider John, who purchases an insurance policy on a racquetball racket that he has acquired. He then proceeds to hit his racket against the wall every time he losses a point. This is an example of

A)an adverse selection problem.
B)a moral hazard problem.
C)signaling.
D)co-insurance.

Question 26

Several students had the idea that they could get rich if they opened a dating service on campus. Others were skeptical that the information on those services is either not true or exaggerated but the enterprising students tell them a campus based system will be much more reliable. This claim

A)makes sense because college students are risk averse by nature and would not make claims that could get them in trouble.
B)makes sense because a campus has many close relationships so exaggerated claims would be easily exposed.
C)does not make sense because college students are risk lovers by nature and would make false claims.
D)is false because the stigma of the newcomer will exclude freshman from the service.

Question 27

When someone with no health insurance buys a high deductible health insurance policy

A)the moral hazard problem is reduced.
B)the premium for the policy falls below what it would be without the deductible.
C)insurance for a large loss is present but small losses are not insured.
D)All of these are true.

Question 28

Which of the following is true of The Stigma of the Newcomer?

A)It is more relevant today because neighbors do not know each other well.
B)It would be more likely to occur in New York City than in a rural community in Iowa.
C)It is less common today than it was several generations ago.
D)It relates to the introduction of new technology so none of the answers are correct.

Question 29

(Appendix) If you have an offer of $10/hour and the relevant range of offers is $5/hour to $15/hour with the offers proportionately distributed across the range, what is your expected gain from engaging in a search for another offer?

A)$2.50
B)$1.25
C)Zero
D)$5.00

Question 30

Your utility function is given by U = M1/2. What is the expected utility of the following coin toss: heads you win $81, tails you win $100?

A)90.5
B)19
C)9.5
D)0

Question 31

Eleanor and her father have identical driving records for the last ten years and neither one has had an accident or insurance claim. Despite that record She pays more for car insurance than he does. What might be the reason for this?

A)Statistical discrimination
B)The moral hazard problem
C)Adverse selection
D)The law of large numbers

Question 32

When a trading opportunity is presented to a heterogeneous group of potential traders, those who accept it will be often

A)worse-on the average, than those who do not accept it.
B)better, on average, than those who do not accept it.
C)no different than those who do not.
D)smarter, on average, than those who do not accept it than those who do not.

Question 33

(Appendix) If the cost of search is $3, and wages are uniformly distributed between $20 and $50, what is the smallest wage you should accept if you are risk neutral?

A)$36.58
B)$33.42
C)$46.58
D)28.73

Question 34

For a large group of individuals, the proportion of people who will have accidents is

A)extremely predictable.
B)extremely unpredictable.
C)always constant.
D)extremely unstable.

Question 35

The Affordable Care Act (Obama Care) requires people to sign up for health insurance or pay a penalty. This seems harsh to some but others claim it is good policy because

A)health care premiums are higher than expected loses even for the highest risk patients.
B)adverse selection will cause premiums to continually increase eliminating many from care.
C)statistical discrimination means that health care plans are losing propositions for everyone.
D)the costly to fake principle implies that it is hard to hide sickness or injury.

Question 36

Megan is trying to decide whether to buy house insurance for her home in Miami. Her house is worth $200,000 and analysts have determined that the average loss from a Hurricane could be $45,000. They have also determined there is a 50 percent chance that she will face a hurricane. Suppose Megan is a risk averse person with a utility-of-income function such as the one given below. If the policy costs $22,500, Megan will

A)buy the insurance.
B)not buy the insurance.
C)be indifferent between buying or not buying the insurance.
D)we can't say.

Question 37

Faced with the gamble: heads you win $100; tails you lose $50, we would predict that a risk-neutral person would

A)take the gamble.
B)refuse the gamble.
C)be indifferent between taking and not taking the gamble.
D)take the gamble but insure against any loses.

Question 38

Your utility function is given by U = M2. You are

A)risk averse.
B)risk neutral.
C)a risk seeker.
D)at is impossible to say.

Question 39

When Jeff bought a house he also bought homeowners insurance, but when he bought a new dishwasher he refused to buy the repair insurance policy the store offered. Assuming Jeff is rational in his choices, which of the following is the most likely cause of his behavior?

A)He switches back and forth between risk averse and risk loving preferences.
B)He doesn't trust appliance insurers because they have no agent to relate to.
C)The probability of his house burning is greater than the probability a dishwasher failure.
D)The expected loss from dishwasher failure is less than the insurance premium and he can afford to absorb smaller losses.

Question 40

If the slope of a person's utility function for different money prizes is linear, the person

A)is risk averse.
B)is a risk lover.
C)is indifferent to risk.
D)We can't really say

Question 41

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is U = 100(M). Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary. Are you risk averse, a risk lover, or risk neutral?

Question 42

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is U = (M)². Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary. What is the expected value of your bike?

Question 43

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is . Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary. Are you a risk lover, risk neutral or risk averse?

Question 44

Evaluate computer database dating services in terms of efficiency. Why have many people avoided these services despite their vast amounts of information? Why might these services become more popular in the future?

Question 45

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is . Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary.
What is the maximum you will pay for the bike check-in now?

Question 46

People accused of a crime frequently claim their innocence. Even if guilty they will sometimes agree to take a lie detector test to see if they can be exonerated. While they may know that these tests do not carry much weight in court there is another reason why they are willing to take the test. Give another valid reason from this chapter explaining why a guilty person would agree to the test.

Question 47

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is U = (M)². Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary. What is the maximum you would pay security to check in your bike?

Question 48

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is U = 100(M). Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary. What is the maximum you will pay the campus security for the safekeeping service now?

Question 49

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is U = (M)². Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary. Campus security has a bike check in that will guard your bike for $15 so there will be no risk of loss. Do you take the campus security deal?

Question 50

Your bike is worth $100 and if you park it outside at school there is a 25% chance that it will be stolen. Your utility function for money is U = (M)². Assume throughout that the bike value and money are interchangeable since you could sell the bike instantly at its value if necessary. Are you a risk taker?

Question 51

Using the simple supply and demand model for the information market, show what the full disclosure principle does to the market. Start from an equilibrium point and apply the concept.