Deck 7: Uncertainty Applications and Criticisms

Question 1

A decrease in variance makes a gamble _______ attractive.

A) less
B) equally
C) more

Answer 1

more

Question 2

A method of avoiding risk whereby groups come together to form a pool so as to share a risk if anyone in the group experiences a negative event is known as

A) risk pooling
B) self-insurance
C) Both answers are correct

Answer 2

Both answers are correct

Question 3

Refer to Exhibit 7-1. Elizabeth is risk preferring; therefore, her utility function most likely looks like Curve (c).

Answer 3

True

Question 4

Risk pooling or self-insurance is a method of avoiding risk whereby groups come together to form a pool so as to share a risk if anyone in the group experiences a negative event.

Question 5

A risk-preferring person such as Elizabeth would be willing to sell insurance at a price

A) of zero
B) This question cannot be answered without knowing the exact shapes of the utility functions
C) at which Elizabeth is indifferent between not insuring a Geoffrey and insuring him

Question 6

Because of the anomalies pointed out by Kahneman and Tversky, the expected utility theory is not a useful tool to help us organize our thinking about economic decision making under conditions of uncertainty.

Question 7

If a risk-averse agent is faced with two gambles, both of which have the same expected monetary return but different variances, the agent will always choose the gamble whose variance is

A) greater
B) smaller
C) equivalent

Question 8

Status quo bias is the term given to the fact that people have resistance to changing their current situations even if the new one offered to them is better.

Question 9

People are more likely to buy insurance if they are

A) risk averse
B) risk preferring
C) risk neutral

Question 10

There ___________________ trading gains to be made in the sale of insurance policies.

A) randomly are or are not
B) are clearly
C) clearly are not

Question 11

The proposition that states that, if a risk-averse agent is faced with two gambles, both of which have the same expected monetary return but different variances, the agent will choose the gamble whose variance is smaller is known as the mean-preserving spread proposition.

Question 12

Risk pooling can cut the variance of losses while keeping the mean intact. Hence, according to the mean-preserving spread proposition, agents will be _____________ with risk pooling than without it.

A) worse off
B) better off
C) no better or worse off

Question 13

Refer to Exhibit 7-1. Geoffrey is risk averse; therefore, his utility function most likely looks like Curve (a).

Question 14

The reflection effect predicts that changing the sign on a set of choices will result in people's changing their preferences, even if the final outcomes and the probabilities attached to them are the same.

Question 15

People tend to think that low probability events are more likely than they are.

Question 16

People are more likely to sell insurance if they are

A) risk averse
B) risk preferring
C) risk neutral

Question 17

The Linda Problem demonstrates violations of the conjunction law.

Question 18

The Ellsberg Paradox illustrates ambiguity aversion.

Question 19

As the population in the risk pool grows larger, the variance in the mean loss approaches

A) positive infinity
B) zero
C) negative infinity

Question 20

The profitability of insurance exists because

A) people have identical attitudes toward risk
B) big insurance companies always charge extremely high rates
C) people have different attitudes toward risk

Question 21

Expected utility theory requires that people

A) assess probabilities in an unbiased manner
B) obey all of the theory's axioms for assigning utilities to outcomes
C) Both answers are correct

Question 22

Firms will continue to enter the insurance industry as long as

A) uncertainty exists
B) there are profits to be made in selling insurance
C) the population in the risk pool remains very small

Question 23

In a survey of university hospital employees, when the insurance causes are broken down to individual cases, people tend to overestimate the probability of each case happening. This is an example of

A) the effect of isolating vivid causes
B) status quo bias
C) the mean-preserving spread proposition

Question 24

People tend to

A) make a distinction between events that are certain and those that are close to, but are not certain
B) think that low probability events are less likely than they are
C) overplay or overweigh events that are close to, but are not certain

Question 25

Researchers who study the application of neuroscience to economics are known as

A) brain surgeons
B) mad monkey doctors
C) neuroeconomists

Question 26

While the marginal utility of increments from the status quo is considered to be _____________, the marginal utility of decrements below the status quo is _____________.

A) decreasing, increasing
B) increasing, decreasing
C) decreasing, constant

Question 27

Explain how a risk-averse buyer of insurance obeys the mean-preserving spread proposition.

Question 28

As a society's agents face the uncertainties in their lives and try to come to terms with these uncertainties,

A) insurance and an insurance industry will emerge
B) the agents will give up hope of success
C) gambling will strenghten as a social disease

Question 29

This is gamble 1: do you prefer a sure win of $5 or a 75% chance to win $8? This is gamble 2: in the first stage, you have an 80% chance to end the game with no prize and a 20% chance to move to the second stage. Before completing the first stage, you must select one of the following second-stage choices: do you prefer a sure win of $5 or a 75% chance to win $8? This is gamble 3: do you prefer a 20% chance to win $5 or a 15% chance to win $8? Which two of the preceding gambles are identical?

A) gamble 1 and 2
B) gamble 2 and 3
C) gamble 1 and 3

Question 30

Why use the expected utility theory?

Question 31

Tina Sierra investigated a fight outside a college classroom. At this college, 75 percent of the students are female and 25 percent are male. Bob, a witness, testified that a male started the fight. After testing, Tina determined that Bob correctly identifies a person's gender 90 percent of the time. Tina concluded that there was a 90 percent chance that a male started the fight. Her mistake is a(n)

A) use of nonlinear probability weights
B) violation of base rates
C) framing error

Question 32

The Ellsberg Paradox is an example of

A) violations of the conjunction law
B) ambiguity aversion
C) violation of base rates

Question 33

When people use ____________ probability weights, people assign too _________ weight to very low probabilities and too _________ to high probabilities.

A) nonlinear, little, much
B) nonlinear, much, little
C) linear, much, little

Question 34

Describe the difference between linear and nonlinear probability weights.

Question 35

Kahneman and Tversky suggest that the way people go about assigning values to utilities of prizes is by

A) defiining for themselves a status quo outcome only
B) judging all outcomes other than the status quo as either gains or losses from the status quo only
C) defiining for themselves a status quo outcome and judging all outcomes other than the status quo as either gains or losses from the status quo

Question 36

This is gamble 1: do you prefer a sure win of $5 or a 75% chance to win $8? This is gamble 2: in the first stage, you have an 80% chance to end the game with no prize and a 20% chance to move to the second stage. Before completing the first stage, you must select one of the following second-stage choices: do you prefer a sure win of $5 or a 75% chance to win $8? This is gamble 3: do you prefer a 20% chance to win $5 or a 15% chance to win $8? Because of framing, which two of the gambles do people tend to treat incorrectly as identical?

A) gamble 1 and 2
B) gamble 2 and 3
C) gamble 1 and 3

Question 37

What is Linda's problem?

Question 38

The Linda Problem is an example of

A) violations of the conjunction law
B) ambiguity aversion
C) violation of base rates

Question 39

Describe the trading gains to be made in the sale of insurance policies.

Question 40

Kahneman and Tversky concluded that people

A) maximize their expected utility by multiplying it by probabilities
B) use probability weights in place of raw probabilities
C) process probabilities in an unbiased and unemotional manner