Question 1

Use the following to answer questions:
Scenario: Buying Shares
Geordie is considering buying shares in two companies, Apple and Microsoft. If he invests $1,000 in Apple, there is a 40% probability that his investment will be worth only $800 and a 60% probability that it will be worth $1,200 at the end of a year. If he invests $500 in Apple, there is a 40% probability that his investment will be worth $400 and a 60% probability that it will be worth $600 at the end of a year. The corresponding numbers for investment in Microsoft are identical.
-(Scenario: Buying Shares) Look at the scenario Buying Shares. The probability that Geordie will make a gain is _____ if he invests $1,000 in either Apple or Microsoft. The probability that he will make a gain is _____ if he invests $500 apiece in Apple and in Microsoft.

Accepted Answer

A)  60%; 60% 
B)  60%; 84% 
C)  76%; 24% 
D)  60%; 36%

Question 2

Which pair of events is NOT independent?

Accepted Answer

A)  You forget your umbrella; it rains. 
B)  There is a heat wave; demand for ice increases. 
C)  You didn't study last night; there is a quiz in your economics class. 
D)  You don't clean your apartment; you have unexpected company.

Question 3

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) Refer to the information in the scenario Choosing Insurance. For $1,000 the Ramirez family can buy insurance that will cover the full cost of repairs. 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 4

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 5

An efficient allocation of risk occurs when those most willing to bear risk insure those who are least willing to bear risk.

Accepted Answer

A) True 
 B)False

Question 6

Use the following to answer questions: 
-(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 7

Use the following to answer questions: 
-(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. Whitney's expected utility is _____ utils.

Accepted Answer

A)  135 
B)  124 
C)  120 
D)  130

Question 8

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

Accepted Answer

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

Question 9

Which pair of events is likely to be positively correlated?

Accepted Answer

A)  stock prices of computer companies and of tire companies 
B)  hurricane damage in Florida and earthquake damage in California 
C)  sales of ice cream and cars on a hot summer day 
D)  a week-long power outage due to a large hurricane and battery sales

Question 10

Consider the marginal utility of income curves of Hank, Babe, Barry, and Willie. Hank's is constant; Babe's is slightly diminishing; Barry's is strongly diminishing; and Willie's is upward-sloping. All else equal, which of these individuals will be most risk-averse?

Accepted Answer

A)  Hank 
B)  Babe 
C)  Barry 
D)  Willie

Question 11

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 12

Micah is considering turning pro before his senior 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 college for his senior year?

Accepted Answer

A)  $3.5 million 
B)  $5 million 
C)  $2 million 
D)  $0

Question 13

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:

Accepted Answer

A)  $410,000. 
B)  $450,000. 
C)  $490,000. 
D)  $485,000.

Question 14

A fair insurance policy is one whose premium is _____ the expected value of the claims.

Accepted Answer

A)  equal to 
B)  greater than 
C)  less than 
D)  unrelated to

Question 15

People faced with adverse selection use _____ to deal with it.

Accepted Answer

A)  screening 
B)  signals 
C)  reputation 
D)  screening, signals, and reputation

Question 16

McDonald's and other fast-food chains rely mainly on franchisees to operate the restaurants to avoid the problem of:

Accepted Answer

A)  adverse selection. 
B)  moral hazard. 
C)  insurance. 
D)  deductibles.

Question 17

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:

Accepted Answer

A)  $10,000. 
B)  $90,000. 
C)  $80,000. 
D)  It is impossible to calculate a premium unless we know Bikul's utility function.

Question 18

Use the following to answer questions: 
-(Table: Utility for Terri and Mary) Look at the table Utility for Terri and Mary. Each has an income of $300. If each were offered insurance to offset the risk of falling income, _____ would pay a larger premium because she is the consumer with _____ risk aversion.

Accepted Answer

A)  Terri; more 
B)  Terri; less 
C)  Mary; more 
D)  Mary; less

Question 19

Use the following to answer questions:
Figure: Risk Aversion 
-(Figure: Risk Aversion) Look at the figure Risk Aversion. Bob and Nancy have the same income and the same total utility. Nancy is _____ risk-averse than Bob because her marginal utility curve is _____ than Bob's.

Accepted Answer

A)  more; flatter 
B)  more; steeper 
C)  less; flatter 
D)  less; steeper

Question 20

Lucy decides to buy car insurance because:

Accepted Answer

A)  she wishes to increase her exposure to risk. 
B)  she wants to decrease her exposure to risk. 
C)  she is not risk-averse. 
D)  her marginal utility is not strongly dependent upon her income.

Exam 20: Uncertainty, Risk, and Private Information

Which pair of events is NOT independent?

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

An efficient allocation of risk occurs when those most willing to bear risk insure those who are least willing to bear risk.

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

Which pair of events is likely to be positively correlated?

Consider the marginal utility of income curves of Hank, Babe, Barry, and Willie. Hank's is constant; Babe's is slightly diminishing; Barry's is strongly diminishing; and Willie's is upward-sloping. All else equal, which of these individuals will be most risk-averse?

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:

A fair insurance policy is one whose premium is _____ the expected value of the claims.

People faced with adverse selection use _____ to deal with it.

McDonald's and other fast-food chains rely mainly on franchisees to operate the restaurants to avoid the problem of:

Use the following to answer questions: -(Table: Utility for Terri and Mary) Look at the table Utility for Terri and Mary. Each has an income of $300. If each were offered insurance to offset the risk of falling income, _ would pay a larger premium because she is the consumer with _ risk aversion.

Use the following to answer questions: Figure: Risk Aversion -(Figure: Risk Aversion) Look at the figure Risk Aversion. Bob and Nancy have the same income and the same total utility. Nancy is _ risk-averse than Bob because her marginal utility curve is _ than Bob's.

Lucy decides to buy car insurance because:

Exam 20: Uncertainty, Risk, and Private Information

Which pair of events is NOT independent?

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

An efficient allocation of risk occurs when those most willing to bear risk insure those who are least willing to bear risk.

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

Which pair of events is likely to be positively correlated?

Consider the marginal utility of income curves of Hank, Babe, Barry, and Willie. Hank's is constant; Babe's is slightly diminishing; Barry's is strongly diminishing; and Willie's is upward-sloping. All else equal, which of these individuals will be most risk-averse?

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:

A fair insurance policy is one whose premium is _____ the expected value of the claims.

People faced with adverse selection use _____ to deal with it.

McDonald's and other fast-food chains rely mainly on franchisees to operate the restaurants to avoid the problem of:

Use the following to answer questions: Figure: Risk Aversion -(Figure: Risk Aversion) Look at the figure Risk Aversion. Bob and Nancy have the same income and the same total utility. Nancy is _____ risk-averse than Bob because her marginal utility curve is _____ than Bob's.

Lucy decides to buy car insurance because:

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

Use the following to answer questions: Figure: Risk Aversion -(Figure: Risk Aversion) Look at the figure Risk Aversion. Bob and Nancy have the same income and the same total utility. Nancy is _ risk-averse than Bob because her marginal utility curve is _ than Bob's.