Question 1

A decrease in variance makes a gamble _______ attractive.
A) less
B) equally
C) more

Accepted Answer

A decrease in variance means the outcomes of the gamble are more predictable and less risky, making it more attractive.

Question 2

A method of avoiding risk whereby groups come together to form a pool so as to share a risk if anyone in the group experiences a negative event is known as
A) risk pooling
B) self-insurance
C) Both answers are correct

Accepted Answer

Risk pooling and self-insurance both involve grouping together to share the financial burden of a potential negative event. Risk pooling typically involves a larger group or organization, while self-insurance is often used by smaller groups or individuals. Both methods can help to minimize the financial impact of risks and protect against unexpected losses.

Question 3

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

Accepted Answer

Elizabeth being risk preferring means she derives more utility from uncertain outcomes than certain ones, which is characteristic of a convex utility function like Curve (c), indicating increasing marginal utility with wealth.

Question 4

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

Accepted Answer

Risk pooling or self-insurance involves forming a pool or group to share a risk in case any member experiences a negative event. Therefore, the statement is true.

Question 5

A risk-preferring person such as Elizabeth would be willing to sell insurance at a price
A) of zero
B) This question cannot be answered without knowing the exact shapes of the utility functions
C) at which Elizabeth is indifferent between not insuring a Geoffrey and insuring him

Accepted Answer

A risk-preferring person like Elizabeth would be willing to sell insurance at a price where she is indifferent between the risk of not insuring and the potential profit from insuring, as she derives utility from taking risks.

Question 6

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

Accepted Answer

Despite the anomalies pointed out by Kahneman and Tversky, expected utility theory remains a foundational tool in economics for understanding decision-making under uncertainty. Their work introduced behavioral insights that complement, rather than invalidate, the expected utility framework by highlighting systematic deviations in human behavior from the predictions of expected utility theory.

Question 7

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

Accepted Answer

Since the agent is risk-averse, they prefer less variability in outcomes. Hence, the agent would choose the gamble with the smaller variance.

Question 8

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

Accepted Answer

Status quo bias is a well-established phenomenon in behavioral economics and psychology where individuals exhibit resistance to changing their current situations even when offered an alternative that is objectively better.

Question 9

People are more likely to buy insurance if they are
A) risk averse
B) risk preferring
C) risk neutral

Accepted Answer

Risk aversion means that people are more likely to avoid potential losses, which makes them more likely to purchase insurance to protect themselves from those losses. Risk preferring individuals, on the other hand, are more willing to take on risk and may be less inclined to purchase insurance. Risk neutrality means that individuals do not have a strong preference for either risk or certainty, and their decision to purchase insurance may depend on other factors.

Question 10

There ___________________ trading gains to be made in the sale of insurance policies.
A) randomly are or are not
B) are clearly
C) clearly are not

Accepted Answer

The statement is suggesting that trading gains can be made in the sale of insurance policies, and the word "clearly" indicates that this is the case.

Question 11

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

Accepted Answer

The statement accurately describes the mean-preserving spread proposition.

Question 12

Risk pooling can cut the variance of losses while keeping the mean intact. Hence, according to the mean-preserving spread proposition, agents will be _____________ with risk pooling than without it.
A) worse off
B) better off
C) no better or worse off

Accepted Answer

Risk pooling reduces the variability of potential losses, without affecting the expected loss (mean). Therefore, the mean-preserving spread proposition suggests that agents will be better off with risk pooling than without it.

Question 13

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

Accepted Answer

The answer of 
-Refer to Exhibit 7-1. Geoffrey is risk...

Question 14

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

Accepted Answer

The statement correctly describes the reflection effect, which has been demonstrated through various studies in behavioral economics and decision-making.

Question 15

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

Accepted Answer

This is known as the availability heuristic, where people tend to overestimate the likelihood of events that come easily to mind, such as memorable or salient events, even if they are actually rare or unlikely.

Question 16

People are more likely to sell insurance if they are
A) risk averse
B) risk preferring
C) risk neutral

Accepted Answer

The answer of People are more likely to sell insurance...

Question 17

The Linda Problem demonstrates violations of the conjunction law.

Accepted Answer

The Linda Problem is a classic example in cognitive psychology that shows how people often make illogical judgments due to violations of the conjunction law.

Question 18

The Ellsberg Paradox illustrates ambiguity aversion.

Accepted Answer

The Ellsberg Paradox is a classic example of ambiguity aversion, which involves a tendency to prefer known risks over unknown risks. The paradox involves a choice between two urns, one of which is known to contain 50 red balls and 50 black balls, while the other has an unknown mix of red and black balls. Many people will choose the first urn, despite the fact that the second urn has an equal chance of winning or losing, simply because the risk is known. This illustrates aversion to ambiguity, or uncertainty about the probabilities involved in a decision.

Question 19

As the population in the risk pool grows larger, the variance in the mean loss approaches
A) positive infinity
B) zero
C) negative infinity

Accepted Answer

This is due to the law of large numbers, which states that as the sample size increases, the sample mean will approach the population mean. Therefore, as the population in the risk pool grows larger, the variability in the mean loss will decrease and approach a more stable value, leading to a variance of zero.

Question 20

The profitability of insurance exists because
A) people have identical attitudes toward risk
B) big insurance companies always charge extremely high rates
C) people have different attitudes toward risk

Accepted Answer

The profitability of insurance exists because people have different attitudes toward risk. Some people are willing to pay a premium to transfer risk while others are willing to take on more risk for a lower premium, which allows insurance companies to make a profit by balancing the needs of different customers. Option A is incorrect because people do not have identical attitudes toward risk. Option B is incorrect because big insurance companies do not always charge extremely high rates; rates are determined based on risk assessment and pricing strategies.

Quiz 7: Uncertainty Applications and Criticisms

A decrease in variance makes a gamble _______ attractive.

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

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

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

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

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

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

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

People are more likely to buy insurance if they are

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

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

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

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

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

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

People are more likely to sell insurance if they are

The Linda Problem demonstrates violations of the conjunction law.

The Ellsberg Paradox illustrates ambiguity aversion.

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

The profitability of insurance exists because