Question 1

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. What certain income leaves Whitney as well off as her uncertain income?

Accepted Answer

A)  $64,000 
B)  $60,000 
C)  $54,000 
D)  $50,000

Question 2

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:

Accepted Answer

A)  expected wealth is $480,000. 
B)  wealth is $500,000 for sure. 
C)  expected wealth is $490,000. 
D)  wealth is $498,000 for sure.

Question 3

If the probability that one person will develop a health problem is greater than that of another person and if they buy insurance from the same provider, most likely the person with a higher probability will pay:

Accepted Answer

A)  the same as the other person. 
B)  more than the person with the lower probability. 
C)  less than the person with the lower probability. 
D)  All people, regardless of probabilities, pay the same amount for insurance.

Question 4

The existence of a large and growing gambling industry clearly shows that many people are risk-loving.

Accepted Answer

A) True 
 B)False

Question 5

The seller of a product will sometimes offer a warranty that if the product is defective, the seller will repair or replace it free of charge within a specified time. What is the role of product warranties in lessening the problem of asymmetric information (or private information) and increasing the number of transactions that are made?

Accepted Answer

The answer of The seller of a product will sometimes...

Question 6

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:

Accepted Answer

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

Question 7

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) Look at the scenario Diversification. If Morris invests half of his money in the sunglass company and half in the rain poncho company, he will earn _____ in a sunny year and _____ in 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 8

The marginal utility of income for a risk-averse individual will be:

Accepted Answer

A)  constant. 
B)  diminishing. 
C)  increasing. 
D)  unknown; the answer depends on the value of income.

Question 9

Insurance companies attempt to minimize moral hazard by imposing:

Accepted Answer

A)  premiums. 
B)  capital at risk. 
C)  adverse selection. 
D)  deductibles.

Question 10

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 11

Use the following to answer questions: 
-(Table: Total Utility of Income After College Expenses) Look at the table Total Utility of Income After College Expenses. The Smith family has _____ 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 12

Organized-gambling venues such as those at Las Vegas tend to attract:

Accepted Answer

A)  risk-loving individuals only. 
B)  even risk-averse people because they are designed to allow individuals to win. 
C)  people who may be irrational in their choice of gambling and are often risk-averse. 
D)  only professional gamblers.

Question 13

Use the following to answer questions:
Scenario: Used Car Market
In the used car market, cars of poor quality are called lemons, while cars of good quality are 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. The expected value of a used car is:

Accepted Answer

A)  $9,000. 
B)  $7,800. 
C)  $18,000. 
D)  $10,500.

Question 14

Asymmetric, or private, information:

Accepted Answer

A)  is an important explanation of the variation (or asymmetric performance) of individuals on standardized tests. 
B)  refers to personal information (e.g., regarding gender or ethnicity) that a person is not obligated to reveal on a job application. 
C)  is relevant for an economic transaction and is known only by some of the people involved in the transaction. 
D)  is protected by patents or copyrights.

Question 15

In which of the following situations is adverse selection most likely to be a problem?

Accepted Answer

A)  buying tomatoes at the local farmers' market 
B)  hiring a new manager to work the night shift 
C)  buying a new lawnmower 
D)  buying a house directly from the previous owner

Question 16

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 $900 the Ramirez family can buy insurance that will cover the full cost of repairs. 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 $49,100, 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.

Question 17

The easiest risks to reduce by diversification are those associated with positively correlated events.

Accepted Answer

A) True 
 B)False

Question 18

Newman has decided to take a road trip in a rental car. He has the minimum amount of personal car insurance to rent the car, but he decides to pay a little extra to the rental car company to completely insure himself against any damage to the rental car. How is there a potential moral hazard due to Newman's purchase of the additional insurance?

Accepted Answer

The answer of Newman has decided to take a road...

Question 19

Insurance premiums often fall substantially if a buyer purchases a policy with a high deductible, and such a policy is often purchased by individuals who self-identify as:

Accepted Answer

A)  low-risk drivers. 
B)  high-risk drivers. 
C)  drivers who do not care what their premium costs are. 
D)  neither high- nor low-risk drivers.

Question 20

Solutions to moral hazard include:

Accepted Answer

A)  offering salespeople in stores a straight salary rather than a commission on sales. 
B)  setting up many stores and restaurants that are part of a national chain as franchises, with the owner undertaking quite a lot of risk. 
C)  allowing property owners to overinsure their buildings. 
D)  diversification.

Exam 20: Uncertainty, Risk, and Private Information