Question 1

You are given the following gamble: behind one door is $500; behind another is $100; behind another is $0. What is the expected value of the gamble?

Accepted Answer

The expected value of the gamble can be calculated by taking the probability of each outcome and multiplying it by its respective payout, and then adding up all the values. In this case, each event has a probability of 1/3. Therefore:
Expected value = (1/3)($500) + (1/3)($100) + (1/3)($0)
Expected value = $200.

Question 2

(Appendix) The winner in an auction bidding process will

Accepted Answer

The answer of (Appendix) The winner in an auction bidding...

Question 3

One thousand tickets are sold at $1 each for a color television valued at $350. What is the expected value of the gain if a person purchases one ticket?

Accepted Answer

The answer of One thousand tickets are sold at $1...

Question 4

Your utility function is given by U = M1/2. You have a choice: take $100 in cash or flip a coin. If you flip a coin, the outcomes are as follows: heads, you win $225; tails, you win $49. You will

Accepted Answer

To determine the preferred option, we calculate the expected utility of the gamble and compare it to the utility of taking $100 in cash. The utility of taking $100 in cash is U($100) = ($100)^{1/2} = 10. For the gamble, the expected utility is the average of the utility of winning $225 and the utility of winning $49, which is (U($225)^{1/2} + U($49)^{1/2}) / 2 = (($225)^{1/2} + ($49)^{1/2}) / 2 ≈ (15 + 7) / 2 = 11. Therefore, since the expected utility of the gamble (11) is higher than the utility of taking $100 in cash (10), the choice would be to take the gamble.

Question 5

Consider John, who purchases an insurance policy on a racquetball racket that he has acquired. He then proceeds to hit his racket against the wall every time he losses a point. This is an example of

Accepted Answer

John's behavior of intentionally damaging his racquetball racket after purchasing an insurance policy is an example of moral hazard. Moral hazard refers to the tendency of individuals to take more risks or engage in risky behavior because they have insurance or will not bear the full cost of their actions. In this case, John's insurance policy may cover the damage he causes to his racket, which incentivizes him to engage in the risky behavior of hitting his racket against the wall.

Question 6

Several students had the idea that they could get rich if they opened a dating service on campus. Others were skeptical that the information on those services is either not true or exaggerated but the enterprising students tell them a campus based system will be much more reliable. This claim

Accepted Answer

The claim that a campus-based dating service will be more reliable because of the close relationships within a campus makes sense. College students often have a social network that is closely interconnected, and any exaggerated claims or false information could easily be exposed. Additionally, the social nature of campus life may make students more likely to seek out a dating service that is trustworthy and reliable. The other options do not make as much sense based on the given information.

Question 7

When someone with no health insurance buys a high deductible health insurance policy

Accepted Answer

All the statements are correct regarding the purchase of a high deductible health insurance policy by someone without prior insurance. A high deductible reduces the moral hazard problem because the insured has to pay a significant amount out-of-pocket before the insurance coverage kicks in, which encourages more responsible behavior. The premium for the policy is lower than it would be for a low-deductible or no-deductible policy because the insurance company's risk is reduced. The policy provides coverage for large losses, which are more catastrophic and financially burdensome, while small losses, which are more manageable, are not covered, encouraging the insured to avoid minor claims and reduce the insurer's costs.

Question 8

Which of the following is true of The Stigma of the Newcomer?

Accepted Answer

The Stigma of the Newcomer is less common today due to increased mobility, globalization, and the blending of cultures, which have made societies more accepting of newcomers compared to several generations ago.

Question 9

(Appendix) If you have an offer of $10/hour and the relevant range of offers is $5/hour to $15/hour with the offers proportionately distributed across the range, what is your expected gain from engaging in a search for another offer?

Accepted Answer

The answer of (Appendix) If you have an offer of...

Question 10

Your utility function is given by U = M1/2. What is the expected utility of the following coin toss: heads you win $81, tails you win $100?

Accepted Answer

Expected value of winning is:
(1/2) x 81 + (1/2) x 100 = 90.5
Expected utility is the square root of expected value:
√90.5 ≈ 9.5
Therefore, the best choice is to take the coin toss, as it has the highest expected utility.

Question 11

Eleanor and her father have identical driving records for the last ten years and neither one has had an accident or insurance claim. Despite that record She pays more for car insurance than he does. What might be the reason for this?

Accepted Answer

Insurance companies use statistical models to determine rates, and it is possible that these models may factor in demographic information such as gender, age, and marital status, which could lead to differential pricing despite identical driving records. This practice is known as statistical discrimination.

Question 12

When a trading opportunity is presented to a heterogeneous group of potential traders, those who accept it will be often

Accepted Answer

This phenomenon is known as adverse selection. Those who accept the trading opportunity are likely to have more information about the potential risks and rewards involved, and therefore more likely to have a higher tolerance for risk. As a result, on average, those who accept the opportunity will be worse-off than those who do not.

Question 13

(Appendix) If the cost of search is $3, and wages are uniformly distributed between $20 and $50, what is the smallest wage you should accept if you are risk neutral?

Accepted Answer

The smallest wage you should accept, often referred to as the reservation wage, can be calculated using the formula for the expected wage (E[W]) minus the cost of search. Given that wages are uniformly distributed between $20 and $50, the expected wage is the average of these two values, which is $35. The cost of search is $3, so the reservation wage is $35 - $3 = $32. However, none of the provided options exactly match this calculation. The closest option to the correct theoretical answer is $36.58 (A), suggesting a possible miscalculation in the question setup or a misunderstanding of the provided options. In practice, the correct approach involves setting the expected gain from searching equal to the cost of search, and solving for the reservation wage in the context of the uniform distribution's properties.

Question 14

For a large group of individuals, the proportion of people who will have accidents is

Accepted Answer

For a large group of individuals, statistical methods allow for the prediction of accidents with a high degree of accuracy. This predictability is based on historical data and probability theories that can forecast the likelihood of accidents within large populations.

Question 15

The Affordable Care Act (Obama Care) requires people to sign up for health insurance or pay a penalty. This seems harsh to some but others claim it is good policy because

Accepted Answer

Adverse selection refers to a situation where sicker individuals are more likely to sign up for health insurance, leading to higher costs for insurers and subsequently higher premiums for everyone. Mandating that everyone gets insurance helps to mitigate this problem by ensuring that the risk pool includes healthier individuals as well, which can help to stabilize or lower premiums.

Question 16

Megan is trying to decide whether to buy house insurance for her home in Miami. Her house is worth $200,000 and analysts have determined that the average loss from a Hurricane could be $45,000. They have also determined there is a 50 percent chance that she will face a hurricane. Suppose Megan is a risk averse person with a utility-of-income function such as the one given below. If the policy costs $22,500, Megan will

Accepted Answer

Megan's expected utility without insurance is:
U(155000) = ln(155000) = 11.95

Her expected utility with insurance is:
0.5U(200000 - 45000 - 22500) + 0.5U(200000 - 22500 - 22500 - 22500) = 
0.5ln(132500) + 0.5ln(155000) = 11.64

Thus, Megan would be better off buying the insurance as it increases her expected utility from 11.95 to 11.64. Therefore, the best choice for Megan is to buy the insurance (Choice A).

Question 17

Faced with the gamble: heads you win $100; tails you lose $50, we would predict that a risk-neutral person would

Accepted Answer

A risk-neutral person would be indifferent to risk and only focus on the expected return, which in this case is ($100 * 0.5) - ($50 * 0.5) = $25. Since the expected return is positive, a risk-neutral person would take the gamble.

Question 18

Your utility function is given by U = M2. You are

Accepted Answer

The utility function U = M2 indicates that the individual has a concave (downward sloping) utility function, which means that they are a risk seeker. This is because the marginal utility of money increases at a decreasing rate, meaning that the individual will prefer a higher expected value of wealth even if there is higher risk or uncertainty involved. Therefore, the best choice would be to take on greater risk for the potential of higher returns.

Question 19

When Jeff bought a house he also bought homeowners insurance, but when he bought a new dishwasher he refused to buy the repair insurance policy the store offered. Assuming Jeff is rational in his choices, which of the following is the most likely cause of his behavior?

Accepted Answer

Jeff is likely behaving rationally and considering the expected cost of a dishwasher repair compared to the cost of the insurance premium. Since the expected loss from a dishwasher failure is less than the insurance premium, he can afford to absorb the smaller losses and therefore chooses not to purchase the repair insurance policy. On the other hand, he did purchase homeowners insurance because the probability of his house burning is greater than the probability of a dishwasher failure, making the potential loss greater and justifying the cost of the insurance premium.

Question 20

If the slope of a person's utility function for different money prizes is linear, the person

Accepted Answer

A linear utility function indicates that the person is indifferent to risk, as their utility increases at a constant rate with money, showing neither risk aversion nor risk seeking behavior.

Quiz 6: The Economics of Information and Choice Under Uncertainty