Question 1

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?

Accepted Answer

A) $0 
B) $10 
C) $20 
D) $30

Question 2

(Table: Amy's Utility Function) Look at the table Choosing Insurance.Amy is an entrepreneur with current income equal to $40,000.Amy is considering development of a new product.The probability that her new product earns Amy $10,000 in additional income is 0.5, and the probability that Amy incurs a reduction of $10,000 from her current income is also 0.5.Suppose Amy can buy a fair insurance policy that will compensate her for any losses.Amy's premium will be ________, her guaranteed income will be , and her expected utility
Will be utils.

Accepted Answer

A) $5,000; $10,000; 200 
B) $10,000; $30,000; 500 
C) $10,000; $40,000; 620 
D) $30,000; $50,000; 720

Question 3

(Table: Income and Utility for Whitney) Look at the table Income and Utility for Whitney.Whitney's income next year is uncertain: there is a 40% probability she will make $40,000 and a 60% probability she will make $80,000.The expected value of Whitney's income is:

Accepted Answer

A) $64,000. 
B) $80,000. 
C) $40,000. 
D) $56,000.

Question 4

(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty.Assume that the probability that the sitcom does not make it to television is 60%, the probability that it makes it to television but is not the most viewed show in its time slot is 30%, and the probability that it makes it to television and is the most viewed show in its time slot is 10%.Norman's expected income is:

Accepted Answer

A) $52,500. 
B) $47,500. 
C) $40,000. 
D) $37,500.

Question 5

A fair insurance policy is one in which the premium equals the expected value of the claim.False

Accepted Answer

A) True 
 B)False

Question 6

An individual finds that as his income increases, his total utility also increases but at a decreasing rate.This can be attributed to:

Accepted Answer

A) diminishing marginal utility. 
B) being risk-neutral. 
C) expected values. 
D) efficient allocation of risk.

Question 7

(Table: Income and Utility for Tyler) The table Income and Utility for Tyler shows the utility Tyler receives at various income levels, but she does not know what her income will be next year.There is a 40% chance her income will be $20,000, a 40% chance her income will be
$30,000, and a 20% chance her income will be $40,000.What is the maximum amount of insurance Tyler would be willing to pay to guarantee an income of $28,000?

Accepted Answer

A) $0 
B) $1,484 
C) $26,516 
D) $126

Question 8

Moral hazard occurs only when people fail to do what is in their best interest.True

Accepted Answer

A) True 
 B)False

Question 9

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

Accepted Answer

A) risk aversion; facilitate 
B) blind strategy; delay 
C) private information; distort 
D) blind trust; diversify

Question 10

(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses.Mr.and Mrs.Smith would be willing to pay as much as for insurance to pay their daughter's tuition and eliminate the uncertainty in the family's income after tuition.

Accepted Answer

A) $12,000 
B) $10,000 
C) $8,000 
D) $5,000

Question 11

Insurance companies deal with the problems created by moral hazard by:

Accepted Answer

A) always insuring buildings for their full replacement value. 
B) refusing to insure commercial properties against losses caused by fire. 
C) providing an incentive for insured individuals to take reasonable precautions to avoid losses by always requiring a deductible. 
D) charging extra in cases of adverse selection.

Question 12

An individual can almost eliminate risk by taking a small share in many independent events or by taking advantage of the predictability associated with large numbers of independent events.This is known as:

Accepted Answer

A) specializing. 
B) floating. 
C) pooling. 
D) insuring.

Question 13

(Table: Income and Utility for Tyler) The table Income and Utility for Tyler shows the utility Tyler receives at various income levels, but she does not know what her income will be next year.There is a 40% chance her income will be $20,000, a 40% chance her income will be
$30,000, and a 20% chance her income will be $40,000.What is her expected utility?

Accepted Answer

A) 3,270 utils 
B) 3,144 utils 
C) 3,420 utils 
D) 3,480 utils

Question 14

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 $1,000.If family members are risk-averse and want to 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 buy the insurance as long as the utility of having a certain income of $48,000 to buy goods and services other than car repairs is higher than the utility associated with their expected income without insurance. 
D) they will self-insure.

Question 15

You are considering the purchase of a $10 ticket for a raffle with a grand prize of $1,000 (assume you are risk neutral).There are two prizes worth $100 and five prizes worth $20.If you know that only 100 tickets will be sold, what is the expected value of your net winnings? Should you purchase the ticket?

Accepted Answer

The answer of You are considering the purchase of a...

Question 16

You are considering the purchase of one ticket for a raffle with a grand prize of $1,000.There are two prizes worth $100 and five prizes worth $20.If you know that only 100 tickets will be sold, what is the most you would pay for one raffle ticket?

Accepted Answer

The answer of You are considering the purchase of one...

Question 17

A insurance policy is an insurance policy for which the premium is equal to the expected value of the claim.

Accepted Answer

A) fair 
B) premium 
C) unfair 
D) diversification

Question 18

(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses.The Smith family experiences marginal utility as income
Increases.The marginal utility of income between $32,500 and $35,000 is utils per
Dollar, while it is utils per dollar between $45,000 and $47,500.

Accepted Answer

A) increasing; 0.48; 0.64 
B) increasing; 0.12; 0.36 
C) diminishing; 0.28; 0.08 
D) diminishing; 0.40; 0.10

Question 19

(Table: Natasha's Total Utility) Look at the table Natasha's Total Utility.Natasha earns $50,000 per year but faces losing $20,000 of it if she is late with her work.If there is a 25% probability that Natasha will be late with her work and her income will equal $30,000, what certain income leaves Natasha just as well off as her uncertain income?

Accepted Answer

A) $37,500 
B) $38,200 
C) $40,500 
D) $42,500

Question 20

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 _.

Accepted Answer

A) increase; increase 
B) decrease; decrease 
C) increase; decrease 
D) decrease; increase

Exam 20: Uncertainty, Risk, and Private Information