Deck 6: Uncertainty and the Emergence of Insurance

Question 1

A probability distribution with a finite number of events is called a discrete probability distribution.

Answer 1

True

Question 2

The expected monetary return of a lottery, gamble, or investment, determined by taking a weighted average of the monetary prizes offered using the associated probabilities as weights is called

A) expected rate of return
B) expected utility
C) expected monetary value

Answer 2

expected monetary value

Question 3

Agents _________ simply choose the option that maximizes their expected monetary payoff; they also evaluate the __________ of each payoff.

A) do not, unselfishness
B) do not, utility
C) do, utility

Answer 3

do not, utility

Question 4

Risk pooling relies upon

A) the average annual amount of rainfall
B) a property of random variables
C) diving headfirst into the shallow end

Question 5

The sum of the various values that a random variable can take on multiplied by the associated probability is known as

A) expected value
B) mean
C) weighted average
D) All of the answers are correct

Question 6

Xavier, Yolanda, and Zachary are considering whether to pool their funds to buy into a lottery. There is a 20% chance that they will win big and make $8 million dollars, a 40% chance that they will win second prize and make $2 million, and a 40% chance that they will lose and win nothing. The entrance fee to participate in this lottery is $3 million. The partners decide whether or not to play by majority vote. Assume that Xavier has utility function u(x) = x². The other two partners have utility function u(x) = x, where x is the total amount of money won in the lottery. Will the partners buy in?

A) All three will vote to buy in, so the partnership as a whole will buy in
B) Only Xavier will vote to buy in, so the partnership as a whole will not buy in
C) Yolanda and Zachary will vote to buy in, so the partnership as a whole will buy in

Question 7

The introduction of insurance makes sense only in a society where something is

A) expensive
B) uncertain or unknown
C) heavily advertised

Question 8

Refer to Exhibit 6-1 for the probability distribution for four different ages that are spread equally throughout a hypothetical population. What is the expected age of the next person to walk into the classroom?

A) 45 years
B) 35 years
C) 55 years

Question 9

Risk neutral is a characteristic of an agent who has a convex utility function (increasing marginal utility).

Question 10

A probability distribution with a finite number of events is called a continuous probability distribution.

Question 11

The distribution that tells us the likelihood that a given random variable will take on any given value is called a(n)

A) probability distribution
B) income distribution
C) variable distribution

Question 12

A continuous probability distribution is a probability distribution with a(n)

A) infinite number of events
B) finite number of events
C) constant number of events

Question 13

Expected utility is the expected utility of a lottery, gamble, or investment, determined by taking a weighted average of the utility of the monetary prizes offered using the associated probabilities as weights.

Question 14

Risk averse is a characteristic of an agent who has a concave utility function (diminishing marginal utility).

Question 15

Variance is a measure that tries to capture the variability of a random variable by looking at the expected squared deviation of the random variable from its mean.

Question 16

The hypothesis that states that, when people are faced with risk, they assess the possible payoffs in terms of utility and then choose the gamble that yields the payoff with the highest expected utility is known as the expected utility hypothesis.

Question 17

Refer to Exhibit 6-2. Which curve has the greater variance?

A) (a)
B) (b)
C) It is necessary to calculate the variances in order to answer

Question 18

Expected monetary value is the expected utility of a lottery, gamble, or investment, determined by taking a weighted average of the utility of the monetary prizes offered using the associated probabilities as weights.

Question 19

Risk preference is a characteristic of an agent who has a convex utility function (increasing marginal utility).

Question 20

A probability distribution is a measure that tries to capture the variability of a random variable by looking at the expected squared deviation of the random variable from its mean.

Question 21

Describe the difference between a discrete and a continuous probability distribution.

Question 22

For Kay Afar, one way of assigning utility to an apple gives a number of 12. Another way gives a number of 30. The first way of assigning utility gives a number of 36 for a banana; the other way gives a number of 217. Either way, Kay chooses the banana. What kind of utility is illustrated by this example?

A) ordinal
B) cardinal
C) agricultural

Question 23

The main behavioral assumption that economists use in analyzing the choices that people make under conditions of uncertainty is the

A) expected monetary value hypothesis
B) expected consumption of utility hypothesis
C) expected utility hypothesis

Question 24

A risk-averse agent will

A) reject a "fair gamble"
B) be indifferent to a "fair gamble"
C) accept a "fair gamble"

Question 25

If utility is measured in a way that not only the utility numbers assigned to bundles are meaningful, but also their differences, then we say that we are using

A) cardinal utility
B) ordinal utility
C) expected utility

Question 26

An agent who has a linear utility function, which implies that the agent will choose between gambles strictly on the basis of their expected monetary value, is risk

A) averse
B) neutral
C) preferring

Question 27

Xavier, Yolanda, and Zachary are considering whether to pool their funds to buy into a lottery. There is a 20% chance that they will win big and make $8 million dollars, a 40% chance that they will win second prize and make $2 million, and a 40% chance that they will lose and win nothing. The entrance fee to participate in this lottery is $2 million. The partners decide whether or not to play by majority vote. Assume that Xavier has utility function u(x) = x². The other two partners have utility function u(x) = x, where x is the total amount of money won in the lottery. Will the partners buy in?

A) All three will vote to buy in, so the partnership as a whole will buy in
B) Only Xavier will vote to buy in, so the partnership as a whole will not buy in
C) Yolanda and Zachary will vote to buy in, so the partnership as a whole will buy in

Question 28

(a)

(b)

(c)

Refer to Exhibit 6-3. Which utility function is risk averse?

A) (a)
B) (b)
C) (c)

Question 29

The analogy of Fahrenheit and Celsius temperature scales best fits

A) additive utility
B) ordinal utility
C) cardinal utility

Question 30

A risk-preferring agent will

A) reject a "fair gamble"
B) be indifferent to a "fair gamble"
C) accept a "fair gamble"

Question 31

What are the characteristics of a risk averse agent?

Question 32

An agent who buys high-priced insurance is most likely

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

Question 33

The theory of expected utility is

A) accepted by all economists
B) not without its detractors
C) able to explain all consumer choices

Question 34

(a)

(b)

(c)

Refer to Exhibit 6-3. Which utility function is risk neutral?

A) (a)
B) (b)
C) (c)

Question 35

Explain why economists generally assume that agents have cardinal utility functions.

Question 36

A risk-neutral agent will

A) reject a "fair gamble"
B) be indifferent to a "fair gamble"
C) accept a "fair gamble"

Question 37

A risk-preferring agent will most likely not buy insurance unless it has a

A) low price
B) neutral price
C) high price

Question 38

Why not maximize expected monetary returns?

Question 39

Consider the test in Experimental Teaser 7 at the beginning of the chapter. How would you predict a risk preferring agent to behave in this experiment?

Question 40

(a)

(b)

(c)

Refer to Exhibit 6-3. Which utility function is risk preferring?

A) (a)
B) (b)
C) (c)