Quiz 20: Uncertainty and Information

Expected wealth is a weighted average in which the weights are A) average utilities. B) marginal utilities. C) total utilities. D) probabilities.

For a risk averse person, an increase in wealth brings ________ total utility of wealth and ________ marginal utility of wealth. A) higher; higher B) higher; lower C) lower; higher D) lower; lower

A risk averse person's utility of wealth curve has a A) positive slope and becomes steeper to the right. B) positive slope and becomes flatter to the right. C) negative slope and becomes steeper to the right. D) negative slope and becomes flatter to the right.

For a risk averse person, the marginal utility of wealth A) decreases as wealth increases. B) increases as wealth increases. C) decreases as wealth decreases. D) remains constant as wealth increases.

The assumption that the marginal utility of wealth diminishes implies that A) total utility falls when wealth increases. B) the marginal utility of wealth is negative. C) total utility increases with wealth and each additional unit of wealth increases total utility by a smaller amount. D) total utility increases with wealth and each additional unit of wealth increases total utility by the same amount.

Assuming that the marginal utility of wealth diminishes implies that A) you have more total utility with $100 than with $1,000. B) you have more total utility with $1,000 than with $1,001. C) an additional dollar increases your total utility more if you only have $100 than if you have $1,000. D) an additional dollar does not increase your total utility regardless of your wealth.

If Ringo is risk averse, at a wealth of $200,000 his utility of wealth curve has a ________ slope and his marginal utility of wealth is ________ than at a wealth of $100,000. A) negative; smaller B) negative; larger C) positive; smaller D) positive; larger

An increase in Meta's wealth from $3,000 to $6,000 raises her utility from 80 units to 100 units. If she is risk averse, with a wealth of $9,000 her utility might be A) 99 units. B) 114 units. C) 120 units. D) 126 units.

An increase in Todd's wealth from $2 million to $4 million raises his utility from 400 units to 500 units. If he has a utility of wealth curve with the typical shape showing risk aversion, then with a wealth of $6 million his utility might be A) 500 units. B) 570 units. C) 600 units. D) 620 units.

Diminishing marginal utility of wealth leads to risk aversion because at a given level of wealth a dollar gained A) is worth more in additional utility than a dollar lost. B) is worth less in additional utility than a dollar lost. C) is worth as much in additional utility as a dollar lost. D) does not add to total utility.

George is considering buying shares of Intel. If the company does well, he will gain $100, but if the company does poorly, he will lose $100. George is risk averse, so for George the magnitude of the pain of losing $100 will ________ the pleasure of gaining $100. A) equal B) be less than C) be greater than D) None of the above answers are correct because we cannot compare the pain of losing to the pleasure of gaining.

For a risk-averse individual, as wealth increases, total utility ________ and marginal utility ________. A) increases; increases B) increases; decreases C) decreases; increases D) decreases; decreases

For a risk-averse individual, as wealth increases, total utility A) increases at a decreasing rate. B) increases at a constant rate. C) increases at an increasing rate. D) is constant.

The slope of the utility of wealth curve of a risk-averse person A) increases as wealth increases. B) decreases as wealth increases. C) is constant. D) is negative.

A risk-averse person's marginal utility of wealth A) increases as wealth increases. B) decreases as wealth increases. C) is constant. D) is negative.

Expected utility is a weighted average in which the weights are A) average incomes. B) marginal incomes. C) total incomes. D) probabilities.

Pedro's utility of wealth is 6 units for $10,000 and 10 units for $20,000. A friend gave him a lottery ticket for his birthday. The ticket won, giving him either $10,000 with probability 0.5 or $20,000 with probability 0.5. Pedro's expected utility from the lottery ticket is A) between 6 and 8 units. B) equal to 8 units. C) between 8 and 10 units. D) equal to 10 units.

You took a summer job as a salesperson in a shoe store with the knowledge that you will either make $2,000 or $3,500 with probabilities 0.4 and 0.6 respectively. What is your expected income for the summer job? A) $2,000 B) $3,000 C) $5,000 D) $2,900

If an individual has a 0.3 probability of receiving $10 and a 0.7 probability of receiving $20, the expected income is A) $20. B) $7. C) $14. D) $17.

Jason is a Web page designer. He estimates that this summer, he has a 0.6 probability of making $10,000 and a 0.4 probability of making only $2,000. What is Jason's expected income this summer? A) $12,000 B) $6,800 C) $6,000 D) $10,000

Christy is a telemarketer. She estimates that this summer, she has a 0.2 probability of earning $10,000, a 0.5 probability of earning $5,000, and a 0.3 probability of earning only $1,000. What is Christy's expected income? A) $7,256 B) $5,333 C) $4,800 D) $4,000

Dana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $10,000 and 50 percent chance that she will make nothing. What's Dana's expected income from taking this job? A) $10,000 B) $7,000 C) $5,000 D) zero

Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. What's Adriana's expected income? A) $4,000 B) $4,500 C) $2,000 D) $3,000

Joe is contemplating a job where, with probability 0.6, he will make $100,000 and with probability 0.4 he will make $30,000. What is Joe's expected income from taking the job? A) $12,000 B) $60,000 C) $72,000 D) $90,000

You took a job as a salesperson in an insurance company with the knowledge that you have 0.5 chance of making $2,000 a month or $3,000 a month. How much will you make each month? A) definitely $2,500 B) definitely $2,000 C) definitely $3,000 D) either $2,000 or $3,000

Hostess Brands is selling off its assets after liquidation. A potential buyer for the Twinkies brand has found that the total revenue will be $3 billion a year if the brand is managed well and $1 billion a year if the brand is managed poorly. There is .6 (or 60 percent) chance of managing the brand well and a .4 (or 40 percent) chance of managing the brand poorly. What is the expected total revenue? A) $0.4 billion B) $1.2 billion C) $1.8 billion D) $2.2 billion

-James has a utility of wealth schedule in the above table. He is offered a job selling video games at Games Galore. James' compensation depends on how much he sells. In a poor sales period, a salesperson makes $100 per month. In a good sales period, a salesperson makes $600 per month. James is told by the manager that, in any given month, there is a 25 percent chance of a poor sales period and a 75 percent chance of a good sales period. What is James' expected income from taking this job? A) $100 B) $350 C) $475 D) $600

-James has a utility of wealth schedule in the above table. He is offered a job selling video games at Games Galore. James' compensation depends on how much he sells. In a poor sales period, a salesperson makes $100 per month. In a good sales period, a salesperson makes $600 per month. James is told by the manager that, in any given month, there is a 25 percent chance of a poor sales period and a 75 percent chance of a good sales period. What is James' expected utility from taking this job? A) 100 B) 150 C) 175 D) 200

-Nancy's utility of wealth curve is given in the above figure. Option A gives Nancy $100 for sure. Option B gives Nancy $50 half the time and $150 half the time. Nancy's expected utility of option A A) is greater than the expected utility of option B. B) is the same as the expected utility of option B. C) is less than the expected utility of option B. D) could be either greater or less than the expected utility of option B.

-Nancy's utility of wealth curve is given in the above figure. She is faced with a risky proposition which yields an income of $50 one-third of the time, $100 one-third of the time, and $150 one-third of the time. Her expected utility is A) 100. B) 140. C) 150. D) 420.

-Dana's utility of wealth is 65 units at $3,000, 80 units at $5,000, and 95 units at $9,000. Starting from zero wealth, he must choose between options A and B. Option A gives him $5,000 for sure. Option B gives him $3,000 with probability 0.5 or $9,000 with probability 0.5. Dana will A) choose option A. B) choose option B. C) be indifferent between option A and option B because they have the same risk. D) be indifferent between option A and option B because they have the same expected utility.

Jessica must choose option A or option B. Option A gives her $10,000 for sure. Option B gives her $5,000 if a fair coin toss shows heads and $15,000 if it shows tails. If Jessica is risk averse her utility of wealth curve becomes A) flatter as her wealth increases and she will choose option A. B) flatter as her wealth increases and she will choose option B. C) steeper as her wealth increases and she will choose option A. D) steeper as her wealth increases and she will choose option B.

Pablo must choose among options A, B, and C. Option A gives him $10,000 for sure. Option B gives him $4,000 with probability 0.5 or $16,000 with probability 0.5. Option C gives him $8,000 with probability 0.5 or $12,000 with probability 0.5. If he receives diminishing marginal utility from wealth, Pablo will A) choose option A. B) choose option B. C) choose option C. D) be indifferent among options A, B, and C.

Nick has two job offers, one as a financial planner and one as an economist for a regional bank. The income that Nick would expect to earn as a financial planner depends how effective he is in getting clients. He estimates that he would receive either $80,000 and a utility of 75, with a probability of .50, or he would earn $30,000 and a utility of 35, with a probability of .50. The economist job would pay $45,000 per year and has a utility of 55. The expected income as a financial planner is ________ and as an economist is ________. A) $60,000; $45,000 B) 55; 55 C) $80,000 and $30,000; $45,000 D) $55,000; $45,000

Nick has two job offers, one as a financial planner and one as an economist for a regional bank. The income that Nick would expect to earn as a financial planner depends how effective he is in getting clients. He estimates that he would receive either $80,000 and a utility of 75, with a probability of .50, or he would earn $30,000 and a utility of 35, with a probability of .50. The economist job would pay $45,000 per year and has a utility of 55. To maximize his expected utility, which job should Nick take? A) Nick is indifferent between the two jobs. B) Nick is better off if he takes the economist job. C) Nick is better off if he takes the job of financial planner. D) Nick should look around for another job.

-Gunnar can work as a campus security officer at a guaranteed salary of $20,000 per year or as a real estate agent. If Gunnar works as a real estate agent, there is a 50 percent chance that he will earn $10,000 per year and a 50 percent chance that he will earn $30,000 per year. Based on the table above, Gunnar's expected utility if he works as a real estate agent is A) 170. B) 85. C) 20. D) 90.

-Gunnar can work as a campus security officer at a guaranteed salary of $20,000 per year or as a real estate agent. If Gunnar works as a real estate agent, there is a 50 percent chance that he will earn $10,000 per year and a 50 percent chance that he will earn $30,000 per year. Based on the above table, to maximize his expected utility, Gunnar will A) choose to work as a campus security officer. B) choose to work as a real estate agent. C) be indifferent between being a campus security officer and being a real estate agent. D) It is impossible to tell which job he would prefer without additional information.

-Andrew's utility of wealth schedule is given in the above table. The table indicates that his marginal utility of wealth ________ as his wealth increases. A) diminishes B) is constant C) increases D) increases first and then diminishes

-Andrew's utility of wealth schedule is given in the above table. Andrew is offered a job as a cook which pays $10,000. He is also offered a job as a server which will pay $5,000 if tips are poor and $15,000 if tips are good. There is a 50 percent chance that tips will be poor and a 50 percent chance that tips will be good. The expected income from the job as a cook is ________ and from the job as a server is ________. A) $10,000; $15,000 B) $5,000; $5,000 C) $10,000; $5,000 D) $10,000; $10,000

-Andrew's utility of wealth schedule is depicted in the above table. Andrew is offered a job as a cook which pays $10,000. He is also offered a job as a server which will pay $5,000 if tips are poor and $15,000 if tips are good. There is a 50 percent chance that tips will be poor and a 50 percent chance that tips will be good. Given the nature of Andrew's job offers and his utility of wealth schedule, Andrew's expected utility from working as a cook is ________ and from working as a server is ________. A) 170 units; 170 units B) 130 units; 190 units C) 170 units; 160 units D) 200 units; 190 units

-Andrew's utility of wealth schedule is depicted in the above table. Andrew is offered a job as a cook which pays $10,000. He is also offered a job as a server which will pay $5,000 if tips are poor and $15,000 if tips are good. There is a 50 percent chance that tips will be poor and a 50 percent chance that tips will be good. Andrew will accept the offer that A) maximizes his expected income. B) maximizes his expected utility. C) maximizes both his expected income and expected utility. D) has the highest weighted average of income and utility.

-Andrew's utility of wealth schedule is depicted in the above table. Andrew is offered a job as a cook which pays $10,000. He is also offered a job as a server which will pay $5,000 if tips are poor and $15,000 if tips are good. There is a 50 percent chance that tips will be poor and a 50 percent chance that tips will be good. Given the nature of Andrew's job offers and his utility of wealth schedule, Andrew will A) accept the offer to work as a server. B) accept the offer to work as a cook. C) be indifferent between working as a cook or a server. D) be unable to reach a decision about which offer to accept.

-Lucy works as a college instructor for a fixed annual salary of $30,000. She is considering quitting this job and becoming a real estate broker. Lucy believes that as a realtor she has a 40 percent chance to make $60,000 per year and a 60 percent chance to make $25,000 a year. The figure above shows Lucy's total utility of wealth curve (U). Lucy's expected annual income from real estate brokerage is A) $39,000. B) $42,500. C) $33,000. D) $47,500.

-Lucy works as a college instructor for a fixed annual salary of $30,000. She is considering quitting this job and becoming a real estate broker. Lucy believes that as a realtor she has a 40 percent chance to make $60,000 per year and a 60 percent chance to make $25,000 a year. The figure above shows Lucy's total utility of wealth curve (U). Lucy's expected utility from real estate brokerage is A) 117. B) 103. C) 110. D) 93.

-Lucy works as a college instructor for a fixed annual salary of $30,000. She is considering quitting this job and becoming a real estate broker. Lucy believes that as a realtor she has a 40 percent chance to make $60,000 per year and a 60 percent chance to make $25,000 a year. The figure above shows Lucy's total utility of wealth curve (U). Lucy will decide to ________ and she will definitely make this choice because it gives her a greater expected ________. A) keep her current job; income B) keep her current job; utility C) quit her job and become a realtor; utility D) quit her job and become a realtor; income

-Lucy works as a college instructor for a fixed annual salary of $30,000. She is considering quitting this job and becoming a real estate broker. Lucy believes that as a realtor she has a 40 percent chance to make $60,000 per year and a 60 percent chance to make $25,000 a year. The figure above shows Lucy's total utility of wealth curve (U). Of the following, what minimum salary raise (if any) should Lucy's current employer offer her to persuade her to stay? A) No raise is necessary as Lucy is better off with her current salary than with her expected income as a realtor. B) $8,000 C) $5,000 D) $3,000

-Marylou, whose utility of wealth curve is shown in the figure above, faces two options. Option A yields her $200 for sure. Option B has a 0.4 probability of yielding $100 and a 0.6 probability of yielding $300. Marylou A) picks option A. B) picks option B. C) is indifferent between option A and option B. D) needs more information to make a choice.

-Marylou, whose utility of wealth curve is shown in the figure above, faces two options. Option A yields $200 for sure. Option B has a 0.3 probability of yielding $100, and a 0.7 probability of yielding $300. Marylou, who is A) picks option A. B) picks option B. C) is indifferent between option A and option B. D) needs more information to make a choice.

Stan, who is risk averse, can invest in project A or project B. Project A returns $3,000 with probability 1/2 and $9,000 with probability 1/2. Project B returns nothing with probability 1/2 and $12,000 with probability 1/2. For Stan, project A has A) greater expected wealth and greater expected utility than project B. B) lower expected wealth and lower expected utility than project B. C) the same expected wealth and the same expected utility as project B. D) the same expected wealth but higher expected utility than project B.

Mel's utility of wealth is 130 units at $3,000, 160 units at $5,000, and 190 units at $9,000. Starting from zero wealth, he must choose between options A and B. Option A gives him $5,000 for sure. Option B gives him $3,000 with probability 0.4 or $9,000 with probability 0.6. Mel A) will choose A. B) will choose B. C) is indifferent between A and B. D) needs more information to make a choice.

Rhonda's utility of wealth is 65 units at $5,000, 80 units at $7,000, and 95 units at $10,000. Starting from zero wealth, she must choose between options A and B. Option A gives her $7,000 for sure. Option B gives her $5,000 with probability 0.6 or $10,000 with probability 0.4. Rhonda A) will choose A. B) will choose B. C) is indifferent between A and B. D) needs more information to make a choice.

The cost of risk is the amount by which expected wealth must increase to give the same ________ as a no-risk situation. A) marginal wealth B) marginal utility C) expected utility D) expected wealth

If Shaniq is a risk averse, then A) her cost of risk exceeds $0. B) she has diminishing marginal utility of wealth. C) she is willing to buy insurance if the cost of insurance is low enough. D) all of the above.

If Pearl is a risk averse, then A) expected utility has nothing to do with her choices. B) she does not have diminishing marginal utility of wealth. C) she will not buy insurance. D) risk is costly to her.

Option A provides $9,000 with probability 50 percent or $11,000 with probability 50 percent. Option B provides $8,000 with probability 50 percent or $12,000 with probability 50 percent. For most people the cost of risk associated with B is A) less than that associated with A. B) the same as that associated with A. C) exactly twice that associated with A. D) more than twice that associated with A.

Kedran is indifferent between option A, which gives her $10,000 for sure, and option B, which gives her $5,000 with probability 0.4 or $15,000 with probability 0.6. Kedran's cost of risk for option B is A) zero. B) $1,000. C) $5,000. D) $10,000.

Nicole is indifferent between option A, which gives her $20,000 for sure, and option B, which gives her $10,000 with probability 0.5 or $32,000 with probability 0.5. Nicole's cost of risk for option B is A) zero. B) $1,000. C) $2,000. D) $20,000.

Goldie is indifferent between option A, which gives her $9,000 for sure, and option B, which gives her $3,000 with probability 1/3 or $18,000 with probability 2/3. Goldie's cost of risk for option B is A) zero. B) $1,000. C) $3,000. D) $4,000.

-Of the choices given below, Jimmy, whose utility of wealth schedule is given above, prefers A) option A: $300 with certainty. B) option B: 50 percent chance of $200 and 50 percent chance of $400. C) option C: 50 percent chance of $200 and 50 percent chance of $700. D) option D: 90 percent chance of $400 and 10 percent chance of $0.

Jimmy's utility of wealth schedule is given in the table above. Jimmy has a job with a one-third chance of earning $200 and a two-thirds chance of earnings $400. Jimmy's cost of risk is A) $0. B) $16.67. C) $33.33. D) Jimmy's cost of risk cannot be determined without more information.

-George is considering investing in a frozen yogurt store. If the store does well he will make $20,0000, but if the store does poorly he will make only $10,000. There is a 50 percent chance of each outcome. His utility of wealth schedule is in the above table. The expected utility of this investment is A) 115. B) 140. C) 165. D) 180.

Based on the table and information in the previous question, which of the following is TRUE? A) George prefers to make $15,000 with certainty than make the investment. B) George prefers making the investment than to make $15,000 with certainty. C) George is indifferent between making $15,000 with certainty and making the investment. D) As the investment has risk George should not make it under any circumstances.

-James has a utility of wealth schedule in the above table. He is offered a job selling video games at Games Galore. James' compensation depends on how much he sells. In a poor sales period, a salesperson makes $100 per month. In a good sales period, a salesperson makes $600 per month. James is told by the manager that, in any given month, there is a 25 percent chance of a poor sales period and a 75 percent chance of a good sales period. Suppose that one of James' professors offers him the opportunity to be a research assistant for a fixed and guaranteed amount each month. What amount must James' professor pay in order to make James indifferent between being a research assistant and working at Games Galore? A) $300 per month B) $350 per month C) $475 per month D) $600 per month

-James has a utility of wealth schedule in the above table. He is offered a job selling video games at Games Galore. James' compensation depends on how much he sells. In a poor sales period, a salesperson makes $100 per month. In a good sales period, a salesperson makes $600 per month. James is told by the manager that, in any given month, there is a 25 percent chance of a poor sales period and a 75 percent chance of a good sales period. Suppose that one of James' professors offers him the opportunity to be a research assistant for a fixed and guaranteed amount each month. Comparing the two opportunities, working at Games Galore versus being a research assistant, what is James' cost of risk? A) $125 per month B) $175 per month C) $375 per month D) $500 per month

-In the figure above, Lourdita faces a 0.5 probability of receiving $3,000 and a 0.5 probability of receiving $9,000. Her cost of bearing this risk is the distance from A) A to F. B) A to D. C) B to E. D) C to E.

-The above figure shows how an individual evaluates a bet in which he or she has a 0.5 probability of receiving $20 and a 0.5 probability of receiving $200. The individual would be indifferent between A) $110 with certainty or the expected value of the bet. B) $80 with certainty or the expected value of the bet. C) $200 with certainty or the expected value of the bet. D) $20 with certainty or the expected value of the bet.

-Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. Her utility of wealth curve is shown in the figure above. What's Adriana's expected utility from taking this job? A) 45 B) $4,500 C) $2,000 D) 40

-Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. Her utility of wealth curve is shown in the figure above. What minimum fixed salary should another employer offer Adriana to persuade her to work for his firm? A) $1,001 B) $2,001 C) $3,001 D) $4,501

-Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. Her utility of wealth curve is shown in the figure above. What's Adriana's cost of risk? A) $2,500 B) $2,000 C) zero D) $40

-Bobby is offered a job as a salesperson in which there is a 50 percent chance that he will make $2,000 and a 50 percent chance that he will make $10,000. Bobby's utility of wealth curve is shown in the figure above. What is Bobby's expected income from taking this job? A) $4,000 B) $6,000 C) $2,000 D) $10,000

-Bobby is offered a job as a salesperson in which there is a 50 percent chance that he will make $2,000 and a 50 percent chance that he will make $10,000. Bobby's utility of wealth curve is shown in the figure above. What is Bobby's expected utility from taking this job? A) 40 B) 50 C) 60 D) 70

-Bobby is offered a job as a salesperson in which there is a 50 percent chance that he will make $2,000 and a 50 percent chance that he will make $10,000. Bobby's utility of wealth curve is shown in the figure above. What is Bobby's cost of risk? A) $1,000 B) $2,000 C) $3,000 D) $4,000

-Bobby is offered two fulltime jobs. In the first job, as a salesperson, he has a 50 percent chance to make $2,000 a month and a 50 percent chance to make $10,000 a month. The second job, as a construction worker, pays $4,500 a month with certainty. Bobby's utility of wealth curve is shown in the figure above. Bobby will take the ________ job because his expected ________ from this job is greater. A) first; utility B) second; utility C) second; income D) first; income

Erika's utility with $3,000 of wealth is 6,000 and her utility with $3,001 of wealth is 6,005. Her marginal utility from gaining the additional $1 of wealth is A) 6,005. B) 3,001. C) 6,000. D) 5.

If Al is risk averse, as his wealth increases, his total utility of wealth ________ and his marginal utility of wealth ________. A) increases; increases B) increases; decreases C) decreases; increases D) decreases; decreases

Soran is risk averse. If her wealth rises by $100, her total utility increases by 300. If her wealth increases, her total utility will decrease A) by more than 300. B) by less than 300. C) by 300. D) by some amount that cannot be determined without more information.

Buying insurance is similar to A) selling risk. B) irrationally avoiding life's risks. C) being a free rider. D) buying risk.

Insurance can be profitable when it A) eliminates risks. B) decreases risks. C) pools risks. D) changes the individual's marginal utility of wealth.

Insurance works because A) all policyholders pay in according to risks and all then receive a pay out in return. B) all policyholders pay in according to risks and then receive a pay out only if they incur a loss. C) all policyholders pay in according to risks and nobody receives any pay out. D) only high risk policyholders pay in while everyone is entitled to a pay out.

You overhear the following in the hallway, "Everyone eventually dies, so how can a life insurance company make a profit? Isn't it a losing battle? You will always have to pay the death benefit to your clients!" You know that life insurance companies can be profitable. This is because A) the premiums you pay on a life insurance policy are always more than any death benefit, so the insurance company always comes out ahead. B) older people with a greater probability of dying during the term of a policy are denied any death benefits. C) the insurance company collects more than enough in premiums today to cover expected benefits payable today. D) life insurance companies are notorious for cheating clients with "fine print" policy clauses.

Insurance is possible and can be profitable because of A) private information. B) adverse selection. C) moral hazard. D) consumers are risk aversion.

Jon is risk averse. When he buys insurance against all risks, then A) he knows his wealth with certainty. B) his utility exceeds his expected utility. C) his wealth exceeds his expected wealth. D) all of the above.

Ashwini is thinking of buying travel insurance (which pays her if she needs to cancel her trip) for her trip to Cancun over spring break. There is a 5 percent chance that she will need to cancel her trip. Without insurance she would lose the full $2,000 price of the trip; with insurance she would get a full refund of $2,000. The premium for this insurance is $105. Which of the following is CORRECT? I. The expected value of Ashwini's loss is $100. II) If Ashwini is risk averse she is willing to buy the insurance only if its price is less than $100. A) I only B) II only C) I and II D) neither I nor II

Many residents of the city of Adelphia drive without automobile insurance. Assuming that Adelphia is just like any other city and these are risk averse individuals, which of the following is most likely TRUE? A) Economic models do not work. B) These people maximize wealth. C) The price of automobile insurance exceeds their maximum value of insurance. D) There are no automobile accidents or thefts in the city of Adelphia.

Dane has a car valued at $20,000 that gives him a utility of 80. There is a 5 percent chance that he will have an accident that will make his car worthless, in which case his utility will be zero. His utility from a wealth of $15,000 is 76. The maximum amount Dane will be willing to pay for insurance is A) $1,000. B) $3,000. C) $5,000. D) $15,000.

Dan has a car valued at $10,000 that gives him a utility of 50 units. There is a 10 percent chance that he will have an accident that will make his car worthless, in which case his utility will be zero. His utility from a wealth of $7,000 is 45 units. The maximum amount Dan will be willing to pay for car insurance is A) $1,000. B) $3,000. C) $7,000. D) zero.

-Beachcomber Beatrice spent her entire wealth of $100,000 to build a beach house on the Gulf of Mexico. There is a 10 percent chance that the house will be totally destroyed by a hurricane. Beatrice's utility of wealth schedule is given in the table above. What is Beatrice's expected wealth? A) $10,000 B) $50,000 C) $90,000 D) $100,000

-Beachcomber Beatrice spent her entire wealth of $100,000 to build a beach house on the Gulf of Mexico. There is a 10 percent chance that the house will be totally destroyed by a hurricane. Beatrice's utility of wealth schedule is given in the table above. What is Beatrice's expected utility of wealth? A) between 0 and 200 B) 245 C) 270 D) between 287 and 300

-Beachcomber Beatrice spent her entire wealth of $100,000 to build a beach house on the Gulf of Mexico. There is a 10 percent chance that the house will be totally destroyed by a hurricane. Beatrice's utility of wealth schedule is given in the table above. What is the minimum amount that the insurance company would require Beatrice to pay for an insurance policy that pays $100,000 if her beach house is destroyed by a hurricane? (Assume the insurance company has no other costs.) A) $10,000 B) $30,000 C) $40,000 D) $60,000

-Beachcomber Beatrice spent her entire wealth of $100,000 to build a beach house on the Gulf of Mexico. There is a 10 percent chance that the house will be destroyed by a hurricane. Beatrice's utility of wealth schedule is given in the table above. What is the maximum amount that Beatrice would be willing to pay for an insurance policy that pays $100,000 if her beach house is destroyed by a hurricane? A) $10,000 B) $30,000 C) $40,000 D) $60,000

-Van, whose utility of wealth curve is shown in the above figure, owns a home that is valued at $100,000. There is a 10 percent chance that the house will be destroyed by hurricane. The minimum cost of insurance in this case is A) $10,000. B) $20,000. C) $30,000. D) $40,000.

-Van, whose utility of wealth curve is shown in the above figure, owns a home that is valued at $100,000. Initially there is a 10 percent chance that the house will be destroyed by hurricane. As the risk of destruction due to hurricane rises from 10 percent to 20 percent, the minimum cost of insurance A) stays the same. B) increases by $10,000. C) increases by $20,000. D) increases by $30,000.

-Van, whose utility of wealth curve is shown in the above figure, owns a home that is valued at $100,000. There is a 10 percent chance that the house will be destroyed by hurricane. The value of insurance to Van is A) $10,000. B) $15,000. C) $20,000. D) $30,000.

-Bruce Copperwood's utility of wealth curve is illustrated in the above figure. Bruce is presently employed at a salary of $100,000. There is a 10 percent probability that Bruce will be totally disabled, in which case he will have no wealth. The maximum amount that Bruce is willing to pay for a disability insurance policy that would pay him $100,000 in the case of total disability is A) $10,000. B) $20,000. C) $80,000. D) $90,000.

-Bruce Copperwood's utility of wealth curve is illustrated in the above figure. Bruce is presently employed at a salary of $100,000. There is a 10 percent probability that Bruce will be totally disabled, in which case he will have no wealth. An insurance company (with no operating expenses) would be willing to offer Bruce a disability insurance policy paying $100,000 in the case of total disability for a minimum premium of A) $1,000. B) $10,000. C) $20,000. D) $90,000.

-Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. With no insurance, Steve's expected wealth is A) $4,000. B) $4,500. C) $3,500. D) $5,000.

-Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. With no insurance, Steve's expected utility is A) 97. B) 84. C) 90. D) 100.

-Steve owns a motorcycle valued at $5,000 and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. What is the maximum insurance premium that Steve is willing to pay? A) $2,000 B) $500 C) $1,000 D) $1,500

-Steve owns a motorcycle valued at $5,000 and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. What is the minimum premium that the insurance company will accept? A) $1,000 B) $2,000 C) $500 D) $1,500

-Steve owns a motorcycle valued at $5,000 and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. Both Steve and the insurance company will gain if the insurance premium is A) $900. B) $1,200. C) $1,600. D) $700.

-Steve owns a motorcycle valued at $5,000 and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. If Steve buys the insurance for $1,000, his expected wealth will be ________, and his expected utility will be ________ than with no insurance. A) greater; greater B) greater; less C) less; greater D) less; less

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. Which of the following statements is TRUE? A) This person has diminishing marginal utility of wealth. B) This person is not risk averse. C) Risky situations cause this person no loss of utility. D) None of the above are correct.

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, what is the person's expected wealth? A) $10,000 B) $20,000 C) $30,000 D) $40,000

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, what is the person's cost of risk? A) $10,000 B) $20,000 C) $30,000 D) $40,000

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, the highest price for insurance this person would pay is A) $0. B) $5,000. C) $10,000. D) $20,000.

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be completely destroyed, would this homeowner buy insurance? A) No, because the homeowner is not risk averse. B) Yes, at any price because the homeowner is risk averse. C) Yes, but only if it costs less than $10,000. D) Yes, but only if it costs less than $20,000.

-The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, would this person buy a $20,000 insurance policy to replace the house if destroyed? A) No, it is too expensive. B) No, he is not risk averse. C) Yes, the homeowner would pay even more. D) Yes, this is the most the homeowner would pay.

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000. If the state lottery offers a 1 in 10,000 chance of winning $10,000, John will A) pay whatever price it takes to play. B) pay $1 to play this game. C) pay less than $1 to play this game. D) not be willing to play this game at any price.

-John's utility of wealth curve is shown in the above figure. He currently has total wealth of $20,000. If there is a 50 percent chance that his $10,000 car will be stolen, then his expected wealth equals A) $0. B) $10,000. C) $15,000. D) $20,000.

-John's utility of wealth curve is shown in the above figure. He currently has total wealth of $20,000. If there is a 50 percent chance that his $10,000 car will be stolen, what is the value of insurance against the theft? A) $0 B) $5,000 C) $7,000 D) $13,000

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000. If there is a 10 percent chance that he could lose all his wealth, what is his expected wealth? A) $0 B) $2,000 C) $17,000 D) $18,000

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000. If there is a 10 percent chance of losing all his wealth, what is the value of insurance against this loss? A) $0 B) $2,000 C) $3,000 D) $17,000

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000 and there is a 10 percent chance of losing it all. John is A) willing to pay any price for insurance. B) willing to pay no more than $2,000 for insurance. C) willing to pay no more than $3,000 for insurance. D) willing to pay $5,000 for insurance.

-John's utility of wealth curve is shown in the above figure. He currently has wealth of $20,000, and there is a 25 percent chance that he could lose it all. If an insurance company offers to insure against this loss for $6,000, John will A) buy the policy. B) not buy the policy. C) be indifferent between being insured and uninsured. D) There is not enough information to answer.

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. What is Andrew's expected wealth? A) $30,000 B) $27,000 C) $20,000 D) zero

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. What is Andrew's expected utility? A) 100 B) 90 C) 50 D) zero

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. Andrew would have the same expected utility as he currently has if his wealth was ________ and he faced no uncertainty. A) $30,000 B) $27,000 C) $21,000 D) $18,000

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. The value of insurance to Andrew against an accident is A) zero. B) $3,000 per year. C) $10,000 per year. D) $6,000 per year.

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000 and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. Suppose all SUV owners are like Andrew. An insurance company agrees to pay each person who has an accident the full value of his/her SUV. The company's operating expenses are $1,500. What is the minimum insurance premium that the company is willing to accept? A) $1,500 per year B) $4,500 per year C) $3,000 per year D) $6,000 per year

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. Suppose all SUV owners are like Andrew. An insurance company agrees to pay each person who has an accident the full value of their SUV. The company's operating expenses are $1,500. Andrew will ________ the company's policy because the minimum insurance premium that the company is willing to accept is ________ the maximum premium that Andrew is willing to pay. A) buy; by $1,500 lower than B) buy; the same as C) not buy; $500 higher than D) not buy; $1,500 higher than

-Ashton has the utility of wealth curve shown in the above figure. He owns a sports car worth $30,000, and that is his only wealth. Ashton is a careless driver and there is a 30 percent chance that he will have an accident within a year. If he does have an accident, his car is worthless. What is Ashton's expected wealth? A) $30,000 B) $9,000 C) $21,000 D) zero

-Ashton has the utility of wealth curve shown in the above figure. He owns a sports car worth $30,000, and that is his only wealth. Ashton is a careless driver and there is a 30 percent chance that he will have an accident within a year. If he does have an accident, his car is worthless. What is Ashton's expected utility? A) 100 B) 30 C) 70 D) zero

-Ashton has the utility of wealth curve shown in the above figure. He owns a sports car worth $30,000, and that is his only wealth. Ashton is a careless driver and there is a 30 percent chance that he will have an accident within a year. If he does have an accident, his car is worthless. Ashton would have the same expected utility as he currently has if his wealth was ________ and he faced no uncertainty. A) $30,000 B) $21,000 C) $12,000 D) $9,000

-Ashton has the utility of wealth curve shown in the above figure. He owns a sports car worth $30,000, and that is his only wealth. Ashton is a careless driver and there is a 30 percent chance that he will have an accident within a year. If he does have an accident, his car is worthless. The maximum amount that Ashton is willing to pay for auto insurance is A) $6,000 per year. B) $3,000 per year. C) $9,000 per year. D) $10,000 per year.

-Ashton has the utility of wealth curve shown in the above figure. Ashton owns a sports car worth $30,000, and that is his only wealth. Ashton is a careless driver and there is a 30 percent chance that he will have an accident within a year. If he does have an accident, his car is worthless. Suppose all sports cars owners are like Ashton. An insurance company agrees to pay each person who has an accident the full value of their car. The company's operating expenses are $1,000. What is the minimum insurance premium that the company is willing to accept? A) $3,000 per year B) $6,000 per year C) $10,000 per year D) $15,000 per year

-Ashton has the utility of wealth curve shown in the above figure. He owns a sports car worth $30,000, and that is his only wealth. Ashton is a careless driver and there is a 30 percent chance that he will have an accident within a year. If he does have an accident, his car is worthless. Suppose all sports cars owners are like Ashton. An insurance company agrees to pay each person who has an accident the full value of their car. The company's operating expenses are $1,000. Ashton will ________ the company's policy because the minimum premium for such insurance that the company is willing to accept is ________ the maximum premium Ashton is willing to pay. A) buy; by $1,500 lower than B) buy; the same as C) not buy; $1,500 higher than D) not buy; $1,000 higher than

Insurance companies A) pool risk and thereby lower people's utility. B) can earn a profit only if people are risk neutral. C) can increase risk averse people's utility. D) try to shift their customers' utility of wealth curves downward.

When Sardar buys insurance, on net he A) gains if the value of the insurance is greater than the price he pays the insurance company. B) loses because the price must pay the insurance company lowers his expected utility. C) gains because his actual wealth with the insurance is greater than his expected wealth without the insurance. D) loses if the price of the insurance equals his expected loss from a bad outcome.

Private information is a situation in which A) two parties to an exchange have information that is available to outsiders if they ask. B) one party to an exchange has information that is not available to the other. C) the marginal cost of a person's obtaining additional information is zero. D) the marginal cost of making information available to one more person is zero.

Of the following, the best example of private information is when A) Michael knows the price of a gallon of milk at the minimart but Michelle doesn't know. B) you know some of your used car's defects but a potential buyer cannot find out about them until after buying. C) you don't know the quality of a used car and must hire a trained mechanic who tells you all its defects. D) you pay the owner of a used car a little extra and she lets you know all of the car's defects.

Moral hazard results from ________ information and adverse selection results from ________ information. A) private; private B) private; public C) public; private D) public; public

Private information A) creates moral hazard but eliminates adverse selection. B) creates adverse selection but eliminates moral hazard. C) creates both moral hazard and adverse selection. D) eliminates both moral hazard and adverse selection.

Moral hazard and adverse selection are the result of A) poorly functioning markets. B) government intervention. C) private information. D) treachery.

Moral hazard occurs ________ an agreement is made and when monitoring the parties to the agreement is ________. A) before; easy B) before; costly C) after; easy D) after; costly

Moral hazard exists chiefly because of A) economies of scale. B) diseconomies of scale. C) private information. D) public information.

Moral hazard is A) the tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party. B) when one of the parties to an agreement has an incentive after the agreement is made to act in a manner that brings additional benefits to himself or herself at the expense of the other party. C) a situation in which only bad quality items are bought and sold. D) an action taken outside a market that conveys information that can be used by that market.

Moral hazard typically occurs because A) people are dishonest. B) agreements sometimes create incentives that are costly to monitor. C) workers possess diminishing marginal productivity. D) workers possess adverse selection.

Moral hazard occurs because people act A) in the interest of others at all time. B) in the best interest of society. C) in their own self-interest. D) like anarchists.

Which of the following is an example of moral hazard? A) I hire you to work in my garden for a fixed fee, and you work hard all day. B) I hire you to work at an hourly rate and you work as slowly as possible. C) You apply for the job only because I pay a fixed wage per day, no matter how much or little you do. D) You agree to be paid by the weed to work in my garden, and then don't work hard.

Because Don has health insurance, he is more likely to see the doctor when he has a cold. This is an example of A) adverse selection. B) moral hazard. C) both moral hazard and adverse selection. D) private information.

If Sally drives less carefully after buying auto insurance, she illustrates A) adverse selection. B) negative selection. C) moral hazard. D) lemon hazard.

Adverse selection is created by A) incentives to change behavior after two parties have reached an agreement. B) risk. C) lump-sum taxes. D) private information.

Adverse selection can occur when A) all parties have full information. B) one party has information not available to the other party. C) incentives result in one party not reaching an agreement with the other party. D) nobody has any information.

The tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party is known as A) adverse selection B) moral hazard. C) the market for oranges. D) a signal.

Adverse selection is the tendency for people who accept contracts to be those who A) buy goods and then regret it later. B) buy goods for more than their own reservation price. C) plan to use private information to the disadvantage of the less well-informed party. D) engage in a number of searches larger than that specified in the contract.

Travel insurance (which pays a traveler if the traveler needs to cancel his or her trip) has a clause that states it will not pay if the trip is cancelled because of a pre-existing condition. If sick people are more likely to purchase travel insurance, this clause is meant to A) reduce moral hazard. B) reduce adverse selection. C) increase moral hazard. D) increase adverse selection.

If a salesperson is paid by the volume of sales he or she makes, then the A) moral hazard problem is diminished. B) moral hazard problem is enhanced. C) adverse selection problem is enhanced. D) there is no effect on the moral hazard problem.

Paying salespeople a fixed wage contract, one in which income does NOT depend on the volume of sales, avoids A) both adverse selection and moral hazard. B) neither adverse selection nor moral hazard. C) adverse selection but not moral hazard. D) moral hazard but not adverse selection.

The use of incentive payments for salespeople combats A) both adverse selection and moral hazard. B) neither adverse selection nor moral hazard. C) adverse selection but not moral hazard. D) moral hazard but not adverse selection.

Even if your college degree is irrelevant to an employer's needs, your high GPA might still get you the job because A) the firm is not a profit maximizer. B) your GPA sends a signal about your quality as a worker. C) the firm will most likely make an adverse selection. D) the high GPA eliminates the possibility of moral hazard.

Signals are believable when the cost of sending a A) false signal is known to be low. B) false signal is known to be high. C) true or false signal is known to be low. D) true signal is known to be high.

A major function of incentive payments, guarantees, and signals is to enable markets to overcome the problem of A) irrational forecasting. B) efficient forecasting. C) private information. D) public information.

Your grade point average acts as ________ to potential employers. A) a signal B) a reservation price C) a guarantee D) insurance

Without warranties, used car buyers can assume that all used cars are "lemons" because of A) moral hazard. B) moral dilemma. C) adverse selection. D) adverse reaction.

In the used car market without warranties, adverse selection results in A) sellers of "lemons" claiming that their car is a lemon. B) only lemons being available for sale. C) the market price of used cars equal to that of good used cars. D) all of the above.

Suppose that there are only two types of used cars, peaches and lemons. Peaches are worth $10,000, and lemons are worth $4,000. If the market is such that only lemons are sold, then used cars are A) experience goods and the used car market has effective signals. B) experience goods and the used car market lacks effective signals. C) not experience goods and the used car market has effective signals. D) not experience goods and the used car market lacks effective signals.

Suppose that there are only two types of used cars, peaches and lemons. Peaches are worth $10,000 and lemons are worth $4,000. Without effective signals such as warranties, the owners of peaches cannot sell their cars for $10,000 because the A) owners of peaches cannot convince buyers that their cars are worth $10,000. B) buyers cannot convince owners of peaches to sell their cars for $10,000. C) owners of lemons cannot convince buyers that their cars are worth more than $4,000. D) buyers cannot convince owners of lemons to sell their cars for $4,000.

Suppose that there are only two types of used cars, peaches and lemons and that used cars are pure experience goods. Peaches are worth $10,000, and lemons are worth $6,000. Three fourths of all used cars are peaches, and one fourth are lemons. In a market with no signals, for instance, a market without warranties, the average value of cars actually sold will be A) $6,000. B) $7,000. C) $9,000. D) $10,000.

Suppose there are only two kind of cars in the market for used cars: lemons and good cars. A lemon is worth $1,000 both to its current owner and to anyone who buys it. A good car is worth $8,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car, and there is no warranty. What is the prevailing price of a used car? A) $8,000 B) $1,000 C) $4,500 D) The prevailing price depends on how many lemons and how many good cars are traded.

The used car market without warranties suffers from A) perfect competition. B) oligopoly. C) adverse selection and moral hazard. D) excessive signaling.

One of the ways the market for used cars copes with the problems associated with private information is through the offering of A) leases. B) warranties. C) low interest rates. D) low prices.

Used car buyers believe a car is good quality when the seller signals the car's quality by offering a warranty because A) car sellers would never lie. B) car buyers are gullible. C) the signal cannot be false. D) a false signal can be costly to the seller.

Used car buyers believe a car is good quality when the seller signals the car's quality by offering a warranty because A) a warranty on a lemon is costly to the seller. B) warranties are only offered on lemons. C) the signal cannot be false. D) a false signal has no effect on the seller.

In the used car market, adverse selection can be limited by A) offering warranties. B) establishing loan limits. C) requiring high deductibles. D) requiring low deductibles.

Warranties in the used car market ________ the problem of private information thereby causing the price of good and bad used cars to ________. A) reduce; be the same B) reduce; differ C) magnify; be the same D) magnify; differ

If a lender checks credit reports on individuals before mailing out loan offers, it is most likely trying to avoid A) moral hazard. B) moral dilemma. C) adverse selection. D) adverse reaction.

Questions about employment history on a loan application are used to prevent A) moral hazard. B) adverse selection. C) market signaling. D) risk aversion.

Dan, age 19, may have trouble buying insurance at a low price because A) the insurance company has private information that he is a risky driver. B) the insurance company has private information that his signals are valid. C) insurance companies fear that he has private information that his deductible is too high. D) insurance companies fear that he has private information that he is a risky driver.

In the market for automobile insurance, adverse selection implies that A) those who are insured might take greater risks. B) those who are uninsured might take greater risks. C) insured and uninsured alike will take greater risks. D) drivers with greater risks are more likely to buy insurance.

In the market for automobile insurance, adverse selection implies that A) drivers with greater risks want to buy a policy without deductibles. B) drivers with greater risks want to buy a policy with large deductibles. C) uninsured drivers will drive recklessly. D) insured drivers will drive recklessly.

In the health insurance market, adverse selection occurs when A) chronically ill people buy health insurance. B) insured people go to the doctor unnecessarily. C) patients sue their doctor. D) people with health insurance tend to behave more recklessly.

Life insurance companies often give applicants a physical examination to prevent A) moral hazard. B) adverse selection. C) signaling. D) warranties.

If a life insurance company offers coverage regardless of age, health status, or smoking history, it is likely to suffer A) moral hazard problems. B) adverse selection problems. C) lower costs. D) low demand for its product.

Bill purchases property insurance for his office building, which includes coverage for fire damage. The policy offers premium discounts for smoke detectors, fire alarms, fire extinguishers and sprinkler systems. This is an incentive system to help avoid A) adverse selection. B) moral hazard. C) optimal-stopping. D) none of the above.

In the market for automobile insurance, moral hazard implies that A) those who are insured might take greater risks. B) those who are uninsured might take greater risks. C) insured and uninsured alike will take greater risks. D) drivers with greater risks are more likely to buy insurance.

In the health insurance market, moral hazard occurs when A) chronically ill people buy insurance. B) insured people go to the doctor unnecessarily. C) patients sue their doctor. D) chronically ill people refuse appropriate medical treatment.

Insurance companies charge a lower premium to drivers who carry a higher deductible because A) insurance companies are not profit maximizers. B) a driver's riskiness decreases as the driver's deductible increases. C) a high deductible signals a high risk. D) insurance companies prefer that drivers carry no deductible.

One way of reducing the moral hazard problem in the automobile insurance market is for drivers to A) carry high deductibles. B) carry no deductibles. C) all have good driving records. D) never make any claims.

If Ben becomes less likely to buy smoke detectors after he has fire insurance, he is illustrating A) moral hazard. B) adverse selection. C) the lemon problem. D) the free rider problem.

If buyers cannot assess the quality of used cars but there are warranties for cars A) too few lemons are sold. B) too many good used cars are sold. C) good used cars are sold at a higher price than lemons. D) there is an adverse selection problem.

If you have private information that you are a safer driver than your record indicates, you are likely to buy an insurance policy with A) a higher than average deductible. B) a positive but lower than average deductible. C) an average deductible. D) no deductible.

Travel insurance (which pays a traveler if the traveler needs to cancel his or her trip) has a clause that states it will not pay if the trip is cancelled because of a pre-existing condition. If sick people are more likely to purchase travel insurance, this clause is meant to A) reduce moral hazard. B) reduce adverse selection. C) increase moral hazard. D) increase adverse selection.

As more information is gather, the marginal cost of additional information ________ and the marginal benefit of additional information ________. A) increases; increases B) increases; decreases C) decreases; increases D) decreases; decreases

There is a growing market for buying and selling information about the online behavior of consumers. Most people use one of only a small number of search engines (such as Google, Bing, or Yahoo!) when surfing the net. It has been hard for new search engines to gain any market share. The market for search is best considered as A) perfectly competitive. B) oligopoly. C) monopolistically competitive. D) monopoly.

Information can be thought of as a A) non-economic piece of data. B) violation of the invisible hand idea that the pursuit of self-interest promotes social interest. C) good whose marginal benefit is infinite. D) good whose marginal benefit decreases as more information is acquired.

Which of the following statements is CORRECT? A) Because information is different from typical goods and services, it cannot be provided in a market. B) The marginal benefit from more information does not decrease. C) Too little information is provided if the market for information is a monopoly. D) Acquiring more information can never be inefficient.

There is a growing market for buying and selling information about the online behavior of consumers. Most people use one of only a small number of search engines (such as Google, Bing, or Yahoo!) when surfing the net. It has been hard for new search engines to gain any market share. Based only on this information, the market for search is best considered as A) perfectly competitive. B) oligopoly. C) monopolistically competitive. D) monopoly.

The International Maritime Bureau said the waters off Somalia are the world's most dangerous, accounting for nearly a third reported pirate attacks worldwide. Suppose all boats are insured to $100,000 and pay a premium of $10,000 each. Suppose 10 out of 100 boats are attacked by pirates and these 10 file claims with their insurance. If the insurance company's only costs are the claims it must pay, has the insurance company earned an economic profit? A) Yes, they earned an economic profit of $90,000. B) No, they broke even. C) No, they sustained an economic loss of $90,000. D) Yes, they earned an economic profit of $1,000,000.

The International Maritime Bureau said the waters off Somalia are the world's most dangerous, accounting for nearly a third reported pirate attacks worldwide. Suppose all boats are insured to $100,000 and pay a premium of $10,000 each. Suppose 10 out of 100 boats are attacked by pirates and these 10 file claims with their insurance. What is the value of the claims? A) one trillion dollars B) one billion dollars C) one million dollars D) one hundred thousand dollars

The International Maritime Bureau said the waters off Somalia are the world's most dangerous, accounting for nearly a third reported pirate attacks worldwide. Suppose all boats are insured to $100,000 and pay a premium of $15,000 each. Suppose 10 out of 100 boats are attacked by pirates and these 10 file claims with their insurance. Has the insurance company earned an economic profit? A) Yes, they earned an economic profit of $500,000. B) Yes, they earned an economic profit of $50,000. C) No, they sustained an economic loss of $85,000. D) No, they broke even.

Mortgage insurance protects lenders when a borrower defaults by making up any shortfall needed to repay the loan if the sale of the property doesn't cover the debt. Federally regulated lenders must have mortgage insurance on loans where the buyer's down payment is less than 20 per cent of the price. In this example, what signal do potential homeowners give to indicate they are low-risk? A) indicating high income B) buying an expensive home C) having a large down payment D) buying an inexpensive home

Mortgage insurance protects lenders when a borrower defaults by making up any shortfall needed to repay the loan if the sale of the property doesn't cover the debt. Federally regulated lenders must have mortgage insurance on loans where the buyer's down payment is less than 20 per cent of the price. This can partially prevent A) symmetric information problems. B) adverse selection problems. C) public information problems. D) the lemon problem.

Mortgage insurance protects lenders when a borrower defaults by making up any shortfall needed to repay the loan if the sale of the property doesn't cover the debt. Federally regulated lenders must have mortgage insurance on loans where the buyer's down payment is less than 20 percent of the price. Why is this 20 percent threshold efficient for the insurance company? A) Information about an individual's mortgage repayment risk is valuable to the insurance company, and the insurance company has found that all individuals fall into this 20 percent threshold. B) Information about an individual's mortgage repayment risk is valuable to the insurance company, but there diminishing marginal cost in obtaining very specific information. C) Information about an individual's mortgage repayment risk is valuable to the insurance company, and the insurance company has found that this 20 percent threshold is perfectly efficient. D) Information about an individual's mortgage repayment risk is valuable to the insurance company, but there diminishing marginal benefit in obtaining very specific information.

Suppose Nara could invest her $1000 in a savings account or she could invest in the stock market. After one year, the savings account has a guaranteed 5 percent interest rate and the stock market has a 10 percent chance of tripling her money, and 90 percent chance of losing it all. What is Nara's expected wealth if she places her money in the savings account? A) $1,050 B) $50 C) $300 D) $1,300

Suppose Nara could invest her $1000 in a savings account or she could invest in the stock market. After one year, the savings account has a guaranteed 5 percent interest rate and the stock market has a 10 percent chance of tripling her money, and 90 percent chance of losing it all. What is the difference in Nara's expected wealth between these two options? A) $1050 B) $300 C) $750 D) $50

Suppose Nara could invest her $1000 in a savings account or she could invest in the stock market. After one year, the savings account has a guaranteed 5 percent interest rate and the stock market has a 10 percent chance of tripling her money, and 90 percent chance of losing it all. What is Nara's expected wealth if she places her money in the stock market? A) $300 B) $1,300 C) $50 D) $1,050

Suppose Nara could invest her $1000 in a savings account or she could invest in the stock market. After one year, the savings account has a guaranteed 5 percent interest rate and the stock market has a 10 percent chance of tripling her money, and 90 percent chance of losing it all. To give Nara the maximum expected wealth, what should she do? A) She should invest all of her money in the stock market. B) She should invest all of her money in the savings account. C) She should invest half of her money in the savings account and half in the stock market. D) She should only invest her money in the stock market if she is risk averse.

Katy has an ailing and wealthy, but miserly, parent. The parent has told Katy that if she takes care of him until he dies, then she will get $100,000 in inheritance. Katy knows that there is only a 50-50 chance that her father will leave her the full amount or nothing. To take care of her father, she has to take a job that pays $30,000 where her current job pays her $70,000 per year. If her father is expected to pass away in 1 year, what is Katy's expected wealth if she takes care of her father? A) $130,000 B) $90,000 C) $80,000 D) $70,000

Katy has an ailing and wealthy, but miserly, parent. The parent has told Katy that if she takes care of him until he dies, then she will get $100,000 in inheritance. Katy knows that there is only a 50-50 chance that her father will leave her the full amount or nothing. To take care of her father, she has to quit her job that pays $60,000 where per year. If her father is expected to pass away in 1 year, what is Katy's expected wealth if she takes care of her father? A) $100,000 B) $50,000 C) $60,000 D) $110,000

In an ad for insurance, the text reads "Life's an adventure, and there are plenty of perils awaiting your jewelry: a lost or broken stone, theft, accidental loss, damage, mysterious disappearance Have you thought about insurance?" What is the economic reasoning for an individual to buy insurance? A) Individuals who buy insurance are profit maximizers. B) Individuals who buy insurance are rational. C) Individuals who buy insurance are dishonest and can profit from dishonesty. D) Individuals who buy insurance increase their expected utility by owning insurance.

In an ad for insurance, the text reads "Life's an adventure, and there are plenty of perils awaiting your jewelry: a lost or broken stone, theft, accidental loss, damage, mysterious disappearance Have you thought about insurance?" How does the inclusion of accidental loss and mysterious disappearance create moral hazard? A) Individuals who purchase insurance are risk averse. B) Those who seek this jewelry insurance know that tend to lose their jewelry often. C) Once insured, some individuals wear their jewelry swimming, exercising, etc. where there is an increased risk of loss. D) Individuals who own jewelry know more about their risk than insurance company.

In an ad for insurance, the text reads "Life's an adventure, and there are plenty of perils awaiting your jewelry: a lost or broken stone, theft, accidental loss, damage, mysterious disappearance Have you thought about insurance?" How does the inclusion of accidental loss and mysterious disappearance create adverse selection? A) Those who seek this jewelry insurance know that tend to lose their jewelry often. B) Individuals who own jewelry know more about their risk than insurance company. C) Once insured, some individuals wear their jewelry swimming, exercising, etc. where there is an increased risk of loss. D) Individuals who purchase insurance are risk averse.

Ebay is an online auction site where individual buyers and sellers receive feedback on their how well they conducted their transaction. This feedback is public available. What is the purpose of this feedback? A) It is a signal that the buyer or seller is reliable. B) To reduce credit risk of a faulty buyer C) To reduce default risk of a faulty seller D) It is a tool to prevent moral hazard.

Pirates have been intensely attacking ships off the shore of Somalia this year. Boat owners have reportedly coughed up more than $30 million in ransom and insurance premiums have shot up. Why would insurance premiums increase dramatically? I. Because the probability of pirate attack has increased II) Because consumers' willingness to pay for insurance has increased because of these attacks III) Because insurance claims have increased A) I only B) I and III only C) III only D) I, II, and III

Pirates have been intensely attacking ships off the shore of Somalia this year. Boat owners have reportedly coughed up more than $30 million in ransom and insurance premiums have shot up. The pirate activity and increase in premiums means that the expected wealth of boat owners who sail near Somalia is A) decreasing. B) increasing. C) staying the same. D) decreasing only if they have insurance.

Pirates have been intensely attacking ships off the shore of Somalia this year. Boat owners have reportedly coughed up more than $30 million in ransom and insurance premiums have shot up. The pirate activity means that the expected utility of wealth of risk averse boat owners who do NOT have insurance and sail near Somalia is A) increasing. B) decreasing. C) staying the same. D) not able to be determined without knowing the extent of risk aversion.

Pirates have been intensely attacking ships off the shore of Somalia this year. Boat owners have reportedly coughed up more than $30 million in ransom and insurance premiums have shot up. If there is a sudden and unexpected increase in risk, who gains? A) insurance companies B) the government of Somalia C) boat owners who are insured with policies whose price cannot be changed D) pirates

What is expected utility?

What does it mean to be risk averse?

How can we measure the cost of risk?

When would a risk averse individual not insure a risky event?

What is private information and what problems does it create?

Explain the concept of moral hazard. Give an example.

"People buy insurance do protect themselves from moral hazard." True or false? Explain.

Most college professors are granted tenure after six years of employment. Tenure implies a lifetime appointment. What problem does this situation create, and how can colleges minimize the problem?

Explain the concept of adverse selection. Give an example.

Consider a market for used cars. Suppose there are only two kinds of cars: lemons and good cars. A lemon is worth $1,500 both to its current owner and to anyone who buys it. A good car is worth $6,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car. What do economists call the problem that buyers of used cars face? What kind of cars (lemons, good cars, or both) are traded? Explain and substantiate your answer.

Consider a market for used cars. Suppose there are only two kind of cars: lemons and good cars. A lemon is worth $1,500 both to its current owner and to anyone who buys it. A good car is worth $6,000 to its current and potential owners. Buyers can't tell whether a car is a lemon until after they have bought the car. What do economists call the problem that buyers of used cars face? What is the price of a used car? Explain and substantiate your answer.

How can a warranty at the seller's expense signal that a product is high quality?

Mike owns a car worth $20,000, and that is his only wealth. There is a 10 percent chance that Mike will have an accident within a year. If he does have an accident, his car is worthless. What is Mike's expected wealth?

-Mike has the utility of wealth curve shown in the figure above. He owns a car worth $20,000, and that is his only wealth. There is a 10 percent chance that Mike will have an accident within a year. If he does have an accident, his car is worthless. a) What is Mike's expected utility? b) What is the maximum amount that Mike is willing to pay for auto insurance? c) Suppose all car owners are like Mike insofar as they have a 10 percent chance of having an accident. An insurance company agrees to pay each person who has an accident the full value of his or her car. The company's operating expenses are $1,000. What is the minimum insurance premium that the company is willing to accept? d) Will Mike buy the company's policy? Why or why not?

A risk averse person has diminishing marginal utility of wealth.

Expected utility is the utility that arises from expected wealth.

The cost of risk is the same for everyone.

A risk averse person will always buy insurance against risk.

Moral hazard occurs when an agreement encourages undesirable behavior.

If reckless drivers are more likely than safe drivers to buy automobile insurance, then a moral hazard problem has occurred.

Adverse selection occurs when a sales offer attracts the kinds of customers that the seller does not want.

If insured drivers decide to drive more recklessly than uninsured drivers do, then an adverse selection has occurred.

-Al works as a sales clerk at a department store for a fixed salary of $2,500 per month. He is offered a job as a salesperson at a car dealership in which there is a 50 percent chance that he will make $5,000 a month and a 50 percent chance that he will make only $1,000 a month. The figure above Al's utility of wealth curve: a) What is Al's expected income from the offered job? b) What is Al's expected utility from the offered job? c) Will Al accept the offer? Why or why not? d) What is the minimum fixed salary for which Al will continue to work for the department store and not accept the dealership's offer?

-Wendy works as a teller at a bank for a fixed salary of $1,800 per month. She is offered a job as a salesperson at which there is a 40 percent chance that she will make $5,000 a month and a 60 percent chance that she will make only $1,000 a month. The figure shows Wendy's utility of wealth curve: a) What is Wendy's expected income from the offered job? b) What is Wendy's expected utility from the offered job? c) Will Wendy accept the offer? Why or why not? d) What is the minimum fixed salary for which Wendy will continue to work for the bank and not take the sales job?

-Larry owns a car worth $20,000, and that is his only wealth. There is a 10 percent chance that Larry will have an accident within a year. If he does have an accident, his car is worthless. Larry's utility of wealth curve is shown in the figure above. An insurance company agrees to pay a car owner like Larry the full value of his car in case of an accident if the car owner buys the company's insurance policy. The company's operating expenses are $2,500 per policy. a) What is Larry's expected wealth? b) What is Larry's expected utility? c) What is the maximum amount that Larry is willing to pay for car insurance? d) What is the minimum premium that the insurance company is willing to accept? e) Will Larry buy the insurance policy? Why or why not?

-Roy owns a sports car worth $40,000, and that is his only wealth. Roy is a reckless driver, and there is a 30 percent chance that he will have an accident within a year. If he does have an accident, his car is worthless. Roy's utility of wealth curve is shown in the figure below. An insurance company agrees to pay a car owner like Roy the full value of his car in case of an accident if the car owner buys the company's insurance policy. The company's operating expenses are $2,000 per policy. a) What is Roy's expected wealth? b) What is Roy's expected utility? c) What is the maximum amount that Roy is willing to pay for car insurance? d) What is the minimum premium that the insurance company is willing to accept? e) Will Roy buy the insurance policy? Why or why not?