Question 1

You are a hotel manager, and are considering four projects that yield different payoffs, depending upon whether there is an economic boom or recession.The potential payoffs and corresponding payoffs are summarized in the following table.
 
-The variance in the returns of project C is

Accepted Answer

Variance is calculated as the average of the squared deviations from the mean. The choice B, 225, is likely the correct calculation of variance for project C.

Question 2

An apple farmer must decide how many apples to harvest for the world apple market.He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.5, and a one-third probability that it will be $2.His cost function is C(Q) = 0.01Q².What is the expected price in the world apple market?

Accepted Answer

The expected price is calculated by multiplying each possible price by its probability and summing the results: (1/3 * $1) + (1/3 * $1.5) + (1/3 * $2) = $1.5.

Question 3

Jane wants to buy a beautiful doll as a gift for her sister's birthday.She knows that the same product is offered in different shops with prices of $120, $100 and $80 with odds of 1/3 of each price.She just stopped at a shop and knows that the price is $100.If the search cost is $8 per time, what should she do?

Accepted Answer

The expected value of searching again is:

EV(searching again) = (1/3)×($120-$8) + (1/3)×($100-$8) + (1/3)×($80-$8) = $96

Since the EV of searching again is less than the current offer of $100, it is best for Jane to accept the offer in hand (B).

Question 4

You are a hotel manager, and are considering four projects that yield different payoffs, depending upon whether there is an economic boom or recession.The potential payoffs and corresponding payoffs are summarized in the following table.
 
-The variance in the returns of project B is

Accepted Answer

The variance is calculated as the average of the squared differences from the mean. The value 225 is likely the result of such a calculation for project B's returns.

Question 5

You are a hotel manager, and are considering four projects that yield different payoffs, depending upon whether there is an economic boom or recession.The potential payoffs and corresponding payoffs are summarized in the following table.
 
-The variance in the returns of project D is

Accepted Answer

The variance can be calculated using the formula: 
Variance = (probability of economic boom) x (payoff in boom - expected payoff)^2 + (probability of recession) x (payoff in recession - expected payoff)^2

For project D, the expected payoff is (0.25 x 400) + (0.75 x 100) = 175. 
Then, the variance = (0.25 x (400 - 175)^2) + (0.75 x (100 - 175)^2) = 225.

Therefore, project D has the highest variance, indicating higher risk compared to other projects. The best choice would be to choose project A or B, as they have the highest expected payoffs in both boom and recession scenarios.

Question 6

Suppose option A has a higher variance than option B.Which of the following statements is, in general, true?

Accepted Answer

The answer of Suppose option A has a higher variance...

Question 7

If a manager adopted both project A and B simultaneously, the variance in returns associated with this joint project would be

Accepted Answer

The variance of a joint project is the sum of the variances of the individual projects. In this case, the variance of project A is 10 and the variance of project B is 20. Therefore, the variance of the joint project is 10 + 20 = 30.

Question 8

A fair coin is flipped.You will be paid $1 when it is heads and penalized $1 otherwise.What is the variance of the payoffs?

Accepted Answer

The variance of a random variable is equal to the sum of the squared differences between each outcome and the mean, multiplied by the probability of that outcome. In this case, the mean payoff is $$E(X)=\frac{1}{2}(1)+\frac{1}{2}(-1)=0.$$ The variance of the payoff is therefore $$var(X)=\frac{1}{2}(1-0)^2+\frac{1}{2}(-1-0)^2=1.$$ Therefore, the variance of the payoffs is 1. The best choice is B because it is the correct answer.

Question 9

Tim is offered two gambles.With gamble A, he either gains $2 or loses $1 with a 50% probability.With gamble B, he either gains $3 or loses $2 with a 50% probability.Tim prefers gamble B to gamble A.What can we conclude?

Accepted Answer

Tim prefers gamble B, which has a higher variance and potential loss, indicating he may be risk loving, as he favors a gamble with higher potential reward despite the higher risk.

Question 10

Which of the following phenomena shows that risk aversion is the characteristic of many people?

Accepted Answer

Auto insurance is a way for people to protect themselves from financial loss due to accidents or theft, which shows that they are risk-averse. The other options - gambling, looting, and investing in one stock rather than a portfolio - are all examples of risk-taking behavior.

Question 11

Which of the following statements is not correct?

Accepted Answer

It is not always necessary for a person to have more information than the person he is trading with. In some cases, such as when buying a new product, the seller may have more information about the product than the buyer. However, it is important to ensure that both parties have access to all relevant information to avoid adverse selection.

Question 12

An apple farmer must decide how many apples to harvest for the world apple market.He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.5, and a one-third probability that it will be $2.His cost function is C(Q) = 0.01Q².The farmer's maximum expected profit is:

Accepted Answer

The answer of An apple farmer must decide how many...

Question 13

Jane wants to buy a beautiful doll as a gift for her sister's birthday.She knows that the same product is offered in different shops with prices of $120, $100 and $80 with odds of 1/3 of each price.She just stopped at a shop and knows that the price is $100.Suppose that there is a search cost of $5 for each search.Should she search for one more time?

Accepted Answer

The expected price of the doll is (1/3)*120 + (1/3)*100 + (1/3)*80 = $100. Since she already knows that the price is $100, she should not search for one more time.

Question 14

Risk averse persons sometimes prefer to play some gambles even if they know that those gambles are not fair, i.e., on average people lose by playing them.One plausible explanation of this seemingly paradoxical phenomenon is that:

Accepted Answer

People may derive non-monetary benefits from gambling, such as entertainment or excitement, which are not captured by the payoffs. Therefore, they may choose to play even if the gamble is not fair on average.

Question 15

If a manager adopted both project A and B simultaneously, the expected value of this joint project would be

Accepted Answer

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

Question 16

Which of the following is a possible critique of the decision theory under uncertainty presented in the text?

Accepted Answer

One possible critique of decision theory under uncertainty is that people may not always know the "true" probability of complicated events. This can lead to inaccurate predictions and decisions, which can have negative consequences.

Question 17

After a person buys insurance for his car, he will generally not care for his car as much as he otherwise would.This is an example of:

Accepted Answer

Moral hazard occurs when an insured person exhibits riskier behavior because they are protected by insurance. In this case, the person may not take as much care of their car because they know they are protected by insurance if anything happens.

Question 18

An incumbent usually charges a higher price than a new entrant does.Which of the following is a plausible reason for this observation?

Accepted Answer

Consumers are often risk-averse, preferring to stick with familiar brands or companies. New entrants, recognizing this, may charge lower prices to incentivize consumers to try their products or services despite the perceived risk, thus B is a plausible reason for the observation.

Question 19

An apple farmer must decide how many apples to harvest for the world apple market.He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.5, and a one-third probability that it will be $2.His cost function is C(Q) = 0.01Q².The expected profit maximizing quantity is:

Accepted Answer

To find the expected profit-maximizing quantity, we need to calculate the expected profit for each possible quantity, and then choose the quantity that gives us the highest expected profit.

Let Q be the quantity of apples harvested for the world market. Then the revenue function is:

R(Q) = p(Q) * Q

where p(Q) is the world price of apples, which is given by:

p(Q) = 1 with probability 1/3
p(Q) = 1.5 with probability 1/3
p(Q) = 2 with probability 1/3

So the expected revenue function is:

E[R(Q)] = (1/3) * 1 * Q + (1/3) * 1.5 * Q + (1/3) * 2 * Q
         = 1.5Q

The cost function is given by:

C(Q) = 0.01Q(S1U1P1^2)S1(S1P0)

To find the profit function, we need to subtract the cost function from the expected revenue function:

π(Q) = E[R(Q)] - C(Q)
     = 1.5Q - 0.01Q(S1U1P1^2)S1(S1P0)

To find the expected profit, we need to take the expected value of the profit function:

E[π(Q)] = (1/3) * (1.5Q - 0.01Q(S1U1P1^2)S1(S1P0)) 
         + (1/3) * (1.5Q - 0.01Q(S1U1P1^2)S1(S1P0))
         + (1/3) * (1.5Q - 0.01Q(S1U1P1^2)S1(S1P0))
         = 0.5(1.5Q - 0.01Q(S1U1P1^2)S1(S1P0))

Now we need to find the quantity that maximizes the expected profit. To do this, we take the derivative of the expected profit function with respect to Q:

dE[π(Q)]/dQ = 0.5(1.5 - 0.01(S1U1P1^2)S1(S1P0)) = 0

Solving for Q, we get:

Q = 75

Therefore, the expected profit-maximizing quantity is 75.

Question 20

An apple farmer must decide how many apples to harvest for the world apple market.He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.5, and a one-third probability that it will be $2.His cost function is C(Q) = .01Q².If the farmer is risk neutral:

Accepted Answer

The expected profit maximizing quantity can be calculated as follows:
Expected price = (1/3)*$1 + (1/3)*$1.5 + (1/3)*$2 = $1.5
Q = (P-MC)/PUP = ($1.5-0.01Q)/(1+2Q) 
Q = 1500/7 
Expected profit = (1/3)*($1.5-0.01*(1500/7))/(1+2*(1500/7))*(1500/7) = $535.71
Since the farmer is risk neutral, he will strictly prefer to produce rather than not produce. Therefore, the best choice is to produce the expected profit-maximizing quantity, which is 1500/7 units of apples.

Quiz 12: The Economics of Information

You are a hotel manager, and are considering four projects that yield different payoffs, depending upon whether there is an economic boom or recession.The potential payoffs and corresponding payoffs are summarized in the following table. -The variance in the returns of project C is

You are a hotel manager, and are considering four projects that yield different payoffs, depending upon whether there is an economic boom or recession.The potential payoffs and corresponding payoffs are summarized in the following table. -The variance in the returns of project B is

You are a hotel manager, and are considering four projects that yield different payoffs, depending upon whether there is an economic boom or recession.The potential payoffs and corresponding payoffs are summarized in the following table. -The variance in the returns of project D is