Question 1

Suppose the probability of a major theft at a hotel is 1%, while the probability of an earthquake hitting the hotel is 2.3%.The probability that both would occur on the same day is therefore:

Accepted Answer

A) 0.00023%. 
B) 0.0023%. 
C) 0.023%. 
D) 2.3%.

Question 2

As the premium for an insurance policy rises, there is a(n):

Accepted Answer

A) decrease in the demand for insurance. 
B) increase in the supply of insurance. 
C) decrease in the quantity demanded of insurance. 
D) decrease in the supply of insurance.

Question 3

By offering a menu of policies with different premiums and deductibles, insurance companies can their customers; for example, a low-risk customer will often buy insurance with a lower ________ but a higher than a high-risk customer.

Accepted Answer

A) signal; deductible; premium 
B) signal; premium; deductible 
C) screen; deductible; premium 
D) screen; premium; deductible

Question 4

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 expects to lose $5,000 at the end of the year.However, if it is a rainy year and he invests only in the rain poncho company, he expects to earn $10,000.If it is a sunny year and he invests only in the sunglass company, he expects to earn $10,000 at the end of the year; if he invests only in the rain poncho company, he expects to 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) Based on the information in the scenario Diversification, if Morris invests half of his money in the sunglass company and half in the rain poncho company, he will earn ________ if it is a sunny year and if it is a rainy year.

Accepted Answer

A) $2,500; $0 
B) $1,250; $1,250 
C) -$2,500; $2,500 
D) $2,500; $2,500

Question 5

The pooling of risk is a form of diversification that produces a payoff with a very ________ risk.

Accepted Answer

A) weak; large 
B) weak; small 
C) strong; large 
D) strong; small

Question 6

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:

Accepted Answer

A) flood insurance providers will reap greater profits. 
B) there will be an increase in the number of insurance companies wishing to provide such insurance. 
C) flood insurance markets may eventually collapse, since the risks of damage cannot be offset through diversification. 
D) flood insurance markets will experience a decrease in the price of premiums.

Question 7

(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses.The Smith family's expected income after tuition is:

Accepted Answer

A) $32,500. 
B) $38,000. 
C) $40,000. 
D) $45,000.

Question 8

Barcelona and Los Angeles are similar towns, except Barcelona has a good public transportation system and Los Angeles does not.Auto insurance will probably be more expensive in ________, since the insurance _.

Accepted Answer

A) Barcelona; demand is higher than in Los Angeles 
B) Barcelona; supply is lower than in Los Angeles 
C) Los Angeles; demand is higher than in Barcelona 
D) Los Angeles; supply is lower than in Barcelona

Question 9

Buying a warranty on a DVD player is an example of paying to avoid risk.False

Accepted Answer

A) True 
 B)False

Question 10

(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty.Suppose the probability that the sitcom does not make it to television is 30%, that it makes it to television but is not the most viewed show in its time slot is 50%, 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 total utility is utils.

Accepted Answer

A) 2,000 
B) 2,150 
C) 2,350 
D) 2,650

Question 11

The funds that an insurance company could potentially pay out are known as the:

Accepted Answer

A) fair premium. 
B) capital at risk. 
C) total premium. 
D) deductible.

Question 12

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

Accepted Answer

A) moral hazard. 
B) adverse selection. 
C) screening. 
D) signaling.

Question 13

When faced with an insurance policy whose premium exceeds the expected value of the claim:

Accepted Answer

A) no one will buy it. 
B) only risk-tolerant individuals will buy it. 
C) risk-averse individuals will buy it as long as the utility associated with the insurance is greater than the expected utility without the insurance. 
D) risk-averse individuals will buy it as long as the utility associated with the insurance is less than the expected utility without the insurance.

Question 14

Amanda recently graduated from college, 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.The expected value of Amanda's income is:

Accepted Answer

A) $40,000. 
B) $21,000. 
C) $28,000. 
D) $10,000.

Question 15

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

Accepted Answer

A) exhibiting risk-averse behavior. 
B) less sensitive to risk than those who requested insurance. 
C) attempting to decrease its exposure to risk. 
D) not very rational in its behavior.

Question 16

Figure: Differences in Risk Aversion
(Figure: Differences in Risk Aversion) Based on the information in the figure Differences in Risk Aversion, which of the following statements is correct?

Accepted Answer

A) Ernest will gain more from insurance than will Salvatore. 
B) Salvatore will gain very little from an increase in income compared with Ernest but will lose a lot of utility from a fall in income. 
C) Ernest is more risk-averse than Salvatore. 
D) If either Ernest or Salvatore buys insurance, adverse selection will occur.

Question 17

Uncertainty about monetary outcomes is known as:

Accepted Answer

A) financial risk. 
B) monetary risk. 
C) profitability risk. 
D) risk aversion.

Question 18

Scenario: Used Car Market In the used car market, cars of poor quality are often referred to as "lemons," while cars that are of good quality are considered to be "plums." Suppose the probability of obtaining a lemon
Is 60% and the probability of obtaining a plum is 40%.Also assume a plum is worth $15,000 and a lemon is worth $3,000.
(Scenario: Used Car Market) Look at the scenario Used Car market.Adverse selection in this used car market occurs because of:

Accepted Answer

A) asymmetric information. 
B) risk-loving behavior. 
C) moral hazard. 
D) diversification.

Question 19

Suppose 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:

Accepted Answer

A) overcharging the family and is not fair. 
B) an example of a fair insurance policy. 
C) undercharging the family. 
D) not appropriate for the family, and they should not buy it.

Question 20

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: state 1, in which their cars need no repairs and their income available for purchasing other goods and services is equal to $50,000; and state 2, in which 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.The Ramirez family can buy insurance that will cover the full cost of repairs for $900.If family members are risk-averse and maximize their expected utility:

Accepted Answer

A) they will buy the insurance. 
B) they will be indifferent between buying and not buying the insurance, since their expected income for purchasing other goods and services is $49,000, regardless of what they do. 
C) they will not buy the insurance, since buying it does not increase their expected income for purchasing other goods and services. 
D) they will self-insure.

Exam 20: Uncertainty, Risk, and Private Information