Question 1

When a buyer does not observe the quality,based on the following table,what is the highest price she will offer for a used car if she ignores adverse selection?
$$\begin{array} { | l | l | l | } 
\hline \text { Types of Cars } & \text { Buyer's Valuation } & \text { Seller's Valuation } \
\hline \begin{array} { l } 
\text { Good } \
\text { (50\% probability) }
\end{array} & 10,000 &9,500 \
\hline \begin{array} { l } 
\text { Bad } \
\text { (50\% probability) }
\end{array} & 5,000 & 4,500 \
\hline
\end{array}$$

Accepted Answer

If the buyer ignores adverse selection, she might assume that the car is equally likely to be of good or bad quality. Therefore, she will calculate the expected value of buying the car as follows:
\begin{align*}
	ext{Expected Value of Buying} &= 	ext{Probability of Good Quality} 	imes 	ext{Buyer's Valuation of Good Quality} \
&+ 	ext{Probability of Bad Quality} 	imes 	ext{Buyer's Valuation of Bad Quality} \
&= 0.5 	imes 10,000 + 0.5 	imes 5,000 \
&= 7,500
\end{align*}
Therefore, the highest price the buyer will offer is $7,500.

Question 2

Based on the following table,what is the highest price that risk-neutral buyers will offer for a used car if they recognize adverse selection?
$$\begin{array} { | l | l | l | } 
\hline \text { Types of Cars } & \text { Buyer's Valuation } & \text { Seller's Valuation } \
\hline \begin{array} { l } 
\text { Good } \
\text { (50\% probability) }
\end{array} & 10,000 &9,500 \
\hline \begin{array} { l } 
\text { Bad } \
\text { (50\% probability) }
\end{array} & 5,000 & 4,500 \
\hline
\end{array}$$

Accepted Answer

The answer of Based on the following table,what is the...

Question 3

Explain why a used car that is only six months old and has been driven only 5,000 miles typically sells for 20 percent less than a new car with the same options.

Accepted Answer

The answer of Explain why a used car that is...

Question 4

A manager is attempting to assess the probability of a recession ending in the next six months and its impact on expected profitability.The manager believes there is a 33 percent chance the recession will end in six months and profits will return to $100 million.However,there is a 67 percent chance the recession will not end in six months,resulting in a $7 million loss.The expected profits over the next six months are:

Accepted Answer

The expected profit is calculated as the sum of the probabilities of each outcome multiplied by the corresponding profit. In this case, the expected profit is:(0.33 * $100 million) + (0.67 * -$7 million) = $28.31 million

Question 5

A risk-neutral,price-taking firm must set output before it knows the market price.There is a 50 percent chance the market demand curve will be Q^d = 10 - 2P and a 50 percent chance it will be Q^d = 20 - 2P.The market supply curve is estimated to be Q^S = 2 + P. a.Calculate the expected (mean)market price. b.Calculate the variance of the market price. c.If the firm's marginal cost is given by MC = 0.01 + 5Q,what level of output maximizes expected profits?

Accepted Answer

The answer of A risk-neutral,price-taking firm must set output before...

Question 6

You are considering opening your own hamburger restaurant.List the information that will influence your decision about whether to start your own restaurant or go with a franchise.

Accepted Answer

The answer of You are considering opening your own hamburger...

Question 7

Joe's search costs are $7 per search.He wants to buy a video player for his wife for Christmas,and the lowest price he's found so far is $200.Joe thinks one-third of the stores charge $300 for a video player,one-third charge $200,and one-third charge $185.Should Joe continue to search or should he buy a video player at a price of $200?

Accepted Answer

The answer of Joe's search costs are $7 per search.He...

Question 8

You are the manager of a new computer company that manufactures PCs to order.Devise a plan that will convince potential customers your quality is the best in the business.

Accepted Answer

The answer of You are the manager of a new...

Question 9

If a manager adopted both project A and project B simultaneously,the expected value of this joint project would be:
$$\begin{array} { | l | l | l | } 
\hline \text { Praject } & \begin{array} { l } 
\text { Bomn } \
( 25 \% )
\end{array} & \begin{array} { l } 
\text { Recessim } \
( 75 \% )
\end{array} \
\hline \text { A } & \$ 30 & - \$ 15 \
\hline \text { B } & - \$ 15 & \$ 20 \
\hline
\end{array}$$

Accepted Answer

The answer of If a manager adopted both project A...

Question 10

As the manager of We Do It Right Construction,you need to make a decision on how many homes to build in a new residential area.There is a 20 percent chance of a recession,a 60 percent chance the economy will remain as it is,and a 20 percent chance there will be an economic upturn.If a recession hits,your inverse demand curve for new homes will be P = 100,000 - 4Q.If things remain as they are,your inverse demand curve will be P = 115,000 - 3Q.If economic growth occurs,your inverse demand curve will be P = 130,000 - 2Q.Your cost function in all three scenarios is C(Q)= 70,000 + 2Q + 0.5Q².If you are risk neutral,how many homes will you start?

Accepted Answer

The answer of As the manager of We Do It...

Question 11

Why do life insurance policies have clauses stipulating that the company will not pay benefits for suicide within one year from the policy date?

Accepted Answer

The answer of Why do life insurance policies have clauses...

Question 12

If a manager adopted both project A and project B simultaneously,the variance in returns associated with this joint project would be:
$$\begin{array} { | l | l | l | } 
\hline \text { Praject } & \begin{array} { l } 
\text { Bomn } \
( 25 \% )
\end{array} & \begin{array} { l } 
\text { Recessim } \
( 75 \% )
\end{array} \
\hline \text { A } & \$ 30 & - \$ 15 \
\hline \text { B } & - \$ 15 & \$ 20 \
\hline
\end{array}$$

Accepted Answer

The variance of the returns for the joint project can be calculated by considering the returns of projects A and B in both economic conditions (Boom and Recession), their probabilities, and the covariance between them. Given the probabilities (25% for Boom and 75% for Recession), we can calculate the expected returns and then the variance.Expected return for each project in each state:- Project A in Boom: $30- Project A in Recession: -$15- Project B in Boom: -$15- Project B in Recession: $20The expected return of the joint project (A+B) in each state:- Boom: $30 - $15 = $15- Recession: -$15 + $20 = $5Expected return of the joint project:$$E(R) = 0.25 \times 15 + 0.75 \times 5 = 3.75 + 3.75 = 7.5$$Variance calculation involves finding the squared deviations from the expected return, weighted by their probabilities:$$Var(R) = 0.25(15 - 7.5)^2 + 0.75(5 - 7.5)^2 = 0.25(56.25) + 0.75(6.25) = 14.0625 + 4.6875 = 18.75$$Thus, the variance in returns associated with adopting both projects A and B simultaneously is 18.75.

Question 13

During the recession in the early 1990s,retailers observed that consumers were spending a lot more time searching for good bargains than ever before,which led the retailers to lower prices.Why?

Accepted Answer

The answer of During the recession in the early 1990s,retailers...

Question 14

When Olympia and York was in the process of restructuring its loans to avoid bankruptcy,its lenders asked the firm to disclose full information about its revenues and costs.Olympia and York,on the other hand,was reluctant to share all of its information with the lenders.Why?

Accepted Answer

The answer of When Olympia and York was in the...

Question 15

Will consumers spend more time searching when stores are located in a mall or when they are spread all over town?

Accepted Answer

The answer of Will consumers spend more time searching when...

Question 16

A risk-averse manager is considering a project that will cost $100.There is a 10 percent chance the project will generate revenues of $100,an 80 percent chance it will yield revenues of $50,and a 10 percent chance it will yield revenues of $500.Should the manager adopt the project?

Accepted Answer

The answer of A risk-averse manager is considering a project...

Question 17

A manager is attempting to assess the probability of a recession ending in the next six months and its impact on expected profitability.The manager believes there is a 33 percent chance the recession will end in six months and profits will return to $100 million.However,there is a 67 percent chance the recession will not end in six months,resulting in a $7 million loss.The standard deviation of profits over the next six months is:

Accepted Answer

The expected profit is calculated as (0.33 * $100 million) + (0.67 * -$7 million) = $28.31 million. The variance is (0.33 * ($100 million - $28.31 million)^2) + (0.67 * (-$7 million - $28.31 million)^2) = $2,531.25 million. The standard deviation is the square root of the variance, which is approximately $50.31 million.

Question 18

Fli-By-Nite Airlines has 1,000 customers.These customers are of two types.Day customers are willing to pay $700 for a flight that has a daytime departure and arrival but only $200 for a flight on the red-eye.Night customers will pay $500 for a flight that has a daytime departure and $300 for a flight on the red-eye.You are the manager for Fli-By-Nite and are unable to determine whether any given individual is a day customer or a night customer.Can you think of a self-selection mechanism that would permit you to identify day and night customers?

Accepted Answer

The answer of Fli-By-Nite Airlines has 1,000 customers.These customers are...

Question 19

"Guaranteed issue" is a controversial topic in the insurance market.It requires firms offering health coverage for one employee to offer the same coverage to all employees,regardless of their health risks.Why is this so controversial?

Accepted Answer

The answer of "Guaranteed issue" is a controversial topic in...

Question 20

As a personnel director of a major consulting firm,you have been asked to decide whether to hire new employees.At present the economy is in a recession,and you have more people than you need to operate the business.Next year there is a 65 percent chance you will need more people and a 35 percent chance you will need fewer people.What additional information would you need when making this decision?

Accepted Answer

The answer of As a personnel director of a major...

Quiz 12: The Economics of Information