Question 1

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)  more insurance companies will provide such insurance. 
C)  flood insurance markets may eventually collapse, since the risks of damage cannot be offset by diversification. 
D)  flood insurance premiums will decrease.

Question 2

As the premium for an insurance policy rises, there is a(n) _____ in the _____ insurance.

Accepted Answer

A)  decrease; demand for 
B)  increase; supply of 
C)  decrease; quantity demanded of 
D)  decrease; supply of

Question 3

Risk-averse individuals:

Accepted Answer

A)  will not gamble at casinos such as those found in Las Vegas. 
B)  will pay higher insurance premiums based on their risk aversion. 
C)  are a minority of the population. 
D)  have upward-sloping marginal utility functions.

Question 4

For most families, total utility does NOT:

Accepted Answer

A)  rise as income rises. 
B)  rise less quickly as income rises. 
C)  show increasing marginal utility. 
D)  show diminishing marginal utility.

Question 5

For most families, the marginal utility of income is:

Accepted Answer

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

Question 6

Insurance companies deal with the problems of 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)  requiring a deductible to provide an incentive for insured individuals to take reasonable precautions to avoid losses. 
D)  charging extra in cases of adverse selection.

Question 7

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 8

Suppose a person rolls a typical six-sided die. What is the probability that the die will come up with a 1 and then a 2?

Accepted Answer

A)  1 in 3 
B)  1 in 36 
C)  1 in 6 
D)  2 in 5

Question 9

Private information can cause economic inefficiency by preventing mutually beneficial transactions.

Accepted Answer

A) True 
 B)False

Question 10

The premium on insurance is often _____ to the deductible, allowing insurance companies to _____ their customers.

Accepted Answer

A)  equal; pool 
B)  directly related; signal 
C)  equal; offer a fair premium to 
D)  inversely related; screen

Question 11

Use the following to answer questions: 
-(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, as a utility maximizer:

Accepted Answer

A)  should keep his teaching job. 
B)  should quit his teaching job and go to Hollywood. 
C)  will be indifferent between leaving and staying, because his expected income is the same whether he stays a teacher or moves to Hollywood. 
D)  will be indifferent between leaving and staying, because his expected total utility is the same whether he stays a teacher or moves to Hollywood.

Question 12

The premium for a(n) _____ insurance policy is equal to the expected value of the claim.

Accepted Answer

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

Question 13

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, To guarantee an income of $50,000, Natasha would be willing to pay _____ for insurance.

Accepted Answer

A)  $4,000 
B)  $5,000 
C)  $7,500 
D)  $9,500

Question 14

Most college-bound high school seniors apply for admission to several colleges of varying reputations and admission standards. Explain how this behavior is similar to diversification of assets discussed in the chapter.

Accepted Answer

The answer of Most college-bound high school seniors apply for...

Question 15

Common strategies to deal with the problem of adverse selection include screening (using observable information to make inferences about private information), signaling (engaging in actions that reveal one's private information), and establishing a good reputation.

Accepted Answer

A) True 
 B)False

Question 16

Use the following to answer questions: 
-(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 17

The total utility of income curve for a risk-averse individual will be _____ with income.

Accepted Answer

A)  decreasing 
B)  increasing at an increasing rate 
C)  increasing at a constant rate 
D)  increasing at a decreasing rate

Question 18

The strategy of investing in several assets so that any possible losses are independent events is:

Accepted Answer

A)  diversification. 
B)  private information. 
C)  moral hazard. 
D)  adverse selection.

Question 19

The funds that an insurance company may have to pay out are known as the:

Accepted Answer

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

Question 20

Risk-averse individuals are willing to pay a premium that is _____ their expected claims.

Accepted Answer

A)  less than 
B)  greater than or equal to 
C)  equal to 
D)  dependent on something other than

Exam 20: Uncertainty, Risk, and Private Information