Question 1

An efficient market for risk,such as an insurance market,is MOST likely to exist:
A)when there is a level playing field so that all participants have approximately the same wealth and the same degree of risk aversion.
B)when the sellers of insurance are risk-averse but the purchasers are not.
C)when there are significant differences between individuals' wealth levels and attitudes toward risk.
D)in the presence of private,or asymmetric,information.

Accepted Answer

An efficient insurance market is likely to exist when there are significant differences in individuals' wealth levels and risk attitudes, as this creates opportunities for risk pooling and sharing, which is the essence of insurance.

Question 2

Suppose that the probability of a major theft at a hotel is 1%,while the probability of an earthquake hitting the hotel is 2.3%.The probability that both would occur on the same day is therefore:
A)0.00023%.
B)0.0023%.
C)0.023%.
D)2.3%.

Accepted Answer

The answer of Suppose that the probability of a major...

Question 3

As the premium for an insurance policy rises,there is a(n)_____ in the _____ insurance.
A)decrease;demand for
B)increase;supply of
C)decrease;quantity demanded of
D)decrease;supply of

Accepted Answer

An increase in the premium for an insurance policy leads to a decrease in the quantity demanded of insurance. This means that as the price of insurance (i.e., premium) increases, consumers are less willing to purchase insurance at the higher price. Therefore, the demand for insurance decreases, leading to a decrease in the quantity demanded of insurance.

Question 4

Which statement describes a principle of the insurance industry?
A)Trade in risk can produce mutual gains.
B)Diversification can increase risk.
C)Deductibles add to the problem of moral hazard.
D)Adverse selection should be used to reduce insurance costs.

Accepted Answer

The principle of insurance is based on the idea that trade in risk can produce mutual gains. Insurance companies use premiums as a means of collecting funds from policyholders, and these funds are then used to pay claims to policyholders who have suffered losses. By pooling these funds, insurance companies are able to spread the financial risks associated with insuring large groups of people, resulting in potential gains for all policyholders.

Question 5

The total amount of funds that potentially could be paid out by an insurance company is the:
A)sum of all premiums collected.
B)sum of all deductibles received from claims.
C)capital at risk.
D)company's liabilities.

Accepted Answer

Capital at risk refers to the total amount of funds that an insurance company could potentially have to pay out in claims. This is distinct from premiums collected, deductibles, or the company's broader liabilities.

Question 6

Which statement is TRUE if the insurance market is efficient?
A)The deductibles eliminate moral hazard.
B)Society as a whole engages in less risky behavior.
C)It transfers risk from those who most want to get rid of it to those least bothered by the risk.
D)Premiums are always kept to the level of a fair insurance policy.

Accepted Answer

The efficient insurance market transfers risk from those who are risk averse (most want to get rid of it) to those who are risk neutral (least bothered by the risk). This is because those who are risk averse are willing to pay a premium to eliminate risk, while those who are risk neutral are willing to accept risk for a lower premium. This balancing of risk among market participants is one of the hallmarks of an efficient insurance market. A) is not necessarily true as deductibles can also create adverse selection. B) is unlikely as insurance can create moral hazard, incentivizing riskier behavior. D) is not necessarily true as premiums will fluctuate based on actuarial data and market conditions.

Question 7

Why might the supply curve of insurance policies shift to the right?
A)The wealth of the sellers of insurance increases.
B)Premiums increase.
C)Risk aversion increases.
D)Diversification increases.

Accepted Answer

The answer of Why might the supply curve of insurance...

Question 8

The strategy of reducing or eliminating risks by taking a small share in many independent events or by taking advantage of the predictability associated with large numbers of independent events is known as:
A)floating.
B)specializing.
C)pooling.
D)screening.

Accepted Answer

The strategy described in the question is called pooling. This involves reducing risk by taking a small share in many independent events or by leveraging the predictability associated with large numbers of independent events. Pooling helps spread risk across multiple events, which can ultimately lead to a more stable and predictable outcome. Floating involves shifting risk to another party, specializing involves focusing on a particular area of expertise, and screening involves separating out high-risk individuals or events from a larger pool. None of these strategies match the description provided in the question.

Question 9

People who want to reduce the risk they face may pay other people who are less sensitive to risk to take on some of their risk.As a result:
A)a market for risk is illegal.
B)trade in risk reduces mutual gains.
C)total risk increases.
D)people who are willing to accept more risk will purchase from people who are less willing.

Accepted Answer

When people who are less sensitive to risk are paid to take on risk from others, it creates a market for risk. This allows people who are more risk-averse to transfer some of their risk to those who are more willing to accept it. This can result in a more efficient allocation of risk and may lead to mutual gains for both parties involved.

Question 10

(Scenario: Buying Shares)Use Scenario: Buying Shares.The probability that Geordie will sustain a loss is _____% if he invests $1,000 in either Apple or Microsoft and _____% if he invests $500 apiece in Apple and in Microsoft. Scenario: Buying Shares
Geordie is considering buying shares in two companies,Apple and Microsoft.If he invests $1,000 in Apple,there is a 40% probability that his investment will be worth only $800 and a 60% probability that it will be worth $1,200 at the end of a year.If he invests $500 in Apple,there is a 40% probability that his investment will be worth $400 and a 60% probability that it will be worth $600 at the end of a year.The corresponding numbers for investment in Microsoft are identical.
A)40;40
B)40;16
C)80;20
D)40;80

Accepted Answer

If Geordie invests $1,000 in either Apple or Microsoft, the possible outcomes and their respective probabilities are:

- $800 (40% probability)
- $1,200 (60% probability)

Therefore, the expected value of his investment would be:

(0.4 x $800) + (0.6 x $1,200) = $1,040

There is a 60% chance that he would make a profit, but there is still a 40% chance that he would sustain a loss.

However, if Geordie invests $500 in both Apple and Microsoft, the possible outcomes and their respective probabilities are:

- $400 (16% probability) [0.4 x 0.4]
- $1,000 (48% probability) [0.6 x 0.4 + 0.4 x 0.6]
- $1,200 (36% probability) [0.6 x 0.6]

Therefore, the expected value of his investment would be:

(0.16 x $400) + (0.48 x $1,000) + (0.36 x $1,200) = $1,080

There is a lower probability of sustaining a loss (16%), and the expected value of his investment is higher ($1,080 compared to $1,040 if he invests $1,000 in one company). Therefore, the best choice is to invest $500 in both Apple and Microsoft.

Question 11

As the premium for an insurance policy falls,there is an increase in the _____ insurance.
A)demand for
B)supply of
C)quantity demanded of
D)quantity supplied of

Accepted Answer

When the premium for an insurance policy falls, the quantity demanded of insurance increases because consumers are more willing to purchase insurance at a lower price.

Question 12

On any particular day,the probability that it will rain is 25% and that you will be sick is 10%.The probability that both happen on the same day is _____%.
A)0.25
B)1
C)2.5
D)17.5

Accepted Answer

The probability that both events happen on the same day is found by multiplying the probabilities of each event: 0.25 (rain) * 0.10 (sick) = 0.025 or 2.5%.

Question 13

Which pair of events is NOT independent?
A)You forget your umbrella;it rains.
B)There is a heat wave;demand for ice increases.
C)You didn't study last night;there is a quiz in your economics class.
D)You don't clean your apartment;you have unexpected company.

Accepted Answer

The answer of Which pair of events is NOT independent?
A)You...

Question 14

Barcelona and Los Angeles are similar,except Barcelona has a good public transportation system and Los Angeles does not.Auto insurance will probably be more expensive in _____ since the _____ for insurance is _____.
A)Barcelona;demand;higher than it is in Los Angeles
B)Barcelona;supply;lower than it is in Los Angeles
C)Los Angeles;demand;higher than it is in Barcelona
D)Los Angeles;supply;lower than it is in Barcelona

Accepted Answer

The statement mentions that Los Angeles does not have a good public transportation system, implying that most people would rely on cars for transportation. This would increase the demand for auto insurance in Los Angeles, making it more expensive than in Barcelona, which has a better public transportation system. Additionally, the question states that the insurance supply is likely to be lower in Barcelona, but this information does not affect the cost of insurance as much as the demand for insurance does.

Question 15

The funds that an insurance company may have to pay out are known as the:
A)fair premium.
B)capital at risk.
C)total premium.
D)deductible.

Accepted Answer

The amount of money that an insurance company may have to pay out to policyholders in the event of claims is known as the capital at risk. This amount may vary based on the type and amount of insurance coverage provided by the policy, as well as the number and severity of claims made by policyholders. The fair premium represents the amount of money that a policyholder must pay for insurance coverage, while the total premium includes all fees and charges associated with the policy, including administrative fees and taxes. A deductible is the portion of a claim that a policyholder must pay before the insurance company begins to pay out.

Question 16

(Scenario: Buying Shares)Use Scenario: Buying Shares.The probability that Geordie will make a gain is _____% if he invests $1,000 in either Apple or Microsoft.The probability that he will make a gain is _____% if he invests $500 apiece in Apple and in Microsoft. Scenario: Buying Shares
Geordie is considering buying shares in two companies,Apple and Microsoft.If he invests $1,000 in Apple,there is a 40% probability that his investment will be worth only $800 and a 60% probability that it will be worth $1,200 at the end of a year.If he invests $500 in Apple,there is a 40% probability that his investment will be worth $400 and a 60% probability that it will be worth $600 at the end of a year.The corresponding numbers for investment in Microsoft are identical.
A)60;60
B)60;84
C)76;24
D)60;36

Accepted Answer

The answer of (Scenario: Buying Shares)Use Scenario: Buying Shares.The probability...

Question 17

Assume that flood insurance premiums are determined in the competitive market.Suppose that devastating floods along the Mississippi River have increased the degree of risk aversion among the insurance investors in this market.The _____ insurance shifts _____,leading to a(n)_____ in equilibrium premiums and a(n)_____ in the quantity of insurance bought and sold.
A)supply of;rightward;decrease;increase
B)demand for;leftward;decrease;decrease
C)supply of;leftward;increase;decrease
D)demand for;rightward;increase;increase

Accepted Answer

When insurance investors become more risk-averse due to devastating floods, they perceive the provision of insurance as riskier. This leads to a leftward shift in the supply of insurance because insurers are less willing to supply insurance at any given price, expecting higher premiums to compensate for the increased risk. Consequently, equilibrium premiums increase, and the quantity of insurance bought and sold decreases.

Question 18

We would consider a tornado and a CEO scandal that hit a construction company on the same day as _____ events.
A)independent
B)dependent
C)premium
D)probable

Accepted Answer

The tornado and the CEO scandal are two separate events that are not influenced by each other, making them independent events. Depending on the context, the other options may not be appropriate. "Dependent" would imply that the tornado and CEO scandal are linked or affect each other. "Premium" does not make sense in this context, as it refers to a high quality or exclusive experience. "Probable" suggests that the occurrence of the two events together is likely, but it does not describe the nature of their relationship.

Question 19

Suppose that the wealth of buyers in the insurance market falls.We would expect insurance premiums to _____ as the _____ curve shifts _____.
A)rise;supply;left
B)fall;supply;right
C)fall;demand;left
D)rise;demand;right

Accepted Answer

The answer of Suppose that the wealth of buyers in...

Question 20

If those who are most willing to bear risk end up bearing it,then we say that the insurance market is:
A)experiencing adverse selection.
B)efficient.
C)equitable.
D)showing signs of moral hazard.

Accepted Answer

When those most willing to bear risk end up bearing it, the insurance market is considered efficient because it means that risks are being allocated to those best able or most willing to manage them. This is a fundamental principle of market efficiency, where resources (in this case, risk-bearing capacity) are allocated to those who value them the most.

Quiz 20: Uncertainty, Risk, and Private Information

An efficient market for risk,such as an insurance market,is MOST likely to exist:

Suppose that the probability of a major theft at a hotel is 1%,while the probability of an earthquake hitting the hotel is 2.3%.The probability that both would occur on the same day is therefore:

As the premium for an insurance policy rises,there is a(n) _ in the _ insurance.

Which statement describes a principle of the insurance industry?

The total amount of funds that potentially could be paid out by an insurance company is the:

Which statement is TRUE if the insurance market is efficient?

Why might the supply curve of insurance policies shift to the right?

The strategy of reducing or eliminating risks by taking a small share in many independent events or by taking advantage of the predictability associated with large numbers of independent events is known as:

People who want to reduce the risk they face may pay other people who are less sensitive to risk to take on some of their risk.As a result:

As the premium for an insurance policy falls,there is an increase in the _____ insurance.

On any particular day,the probability that it will rain is 25% and that you will be sick is 10%.The probability that both happen on the same day is _____%.

Which pair of events is NOT independent?

Barcelona and Los Angeles are similar,except Barcelona has a good public transportation system and Los Angeles does not.Auto insurance will probably be more expensive in ___ since the _ for insurance is ___.

The funds that an insurance company may have to pay out are known as the:

We would consider a tornado and a CEO scandal that hit a construction company on the same day as _____ events.

Suppose that the wealth of buyers in the insurance market falls.We would expect insurance premiums to ___ as the _ curve shifts ___.

If those who are most willing to bear risk end up bearing it,then we say that the insurance market is: