Question 1

If the probability that one person will develop a health problem is greater than that of another person and if they buy insurance from the same provider, most likely the person with a higher probability will pay:

Accepted Answer

Insurance premiums are typically based on risk assessment, so a person with a higher probability of developing a health problem is likely to pay more to cover the increased risk.

Question 2

Given uncertainty, individuals attempt to maximize their:

Accepted Answer

Expected utility is the measure of the satisfaction or happiness that an individual gains from a particular decision in a context of uncertainty. It takes into account both the possible outcomes and probabilities of each outcome. Therefore, maximizing expected utility helps individuals to make the best decision under uncertainty. Adverse selection refers to the tendency for individuals with higher risk to be more likely to participate in an agreement, while risk aversion is the preference for a certain outcome with lower risks, rather than betting on a higher but uncertain outcome. Consumption is a general term referring to the use of goods and services.

Question 3

Use the following to answer questions:
Scenario: Health Costs
Alan is hoping for a healthy year, meaning that he would have zero health costs. Given his habits, there is a 40% chance that Alan will develop a health issue resulting in $50,000 in health costs. Assume these are the only two conditions that could exist for Alan in the coming year.
-(Scenario: Health Costs) Look at the scenario Health Costs. Given the fact that Alan has a 40% chance of developing a health problem, what is the expected value of Alan's health care costs for the coming year?

Accepted Answer

Expected value = (probability of event) * (value if event occurs)Expected value = (0.4) * ($50,000) + (0.6) * ($0) = $20,000

Question 4

Two consumers go to the insurance company to purchase life insurance. James is a smoker and a police officer who races motorcycles in his spare time. Kathy is a nonsmoker and a librarian who likes to make quilts in her spare time. The insurance company knows that both consumers are 40 years old, but the company has no information about occupations or hobbies. How does the private information in this situation set up an adverse-selection problem? How could the insurance company lessen this problem?

Accepted Answer

The answer of Two consumers go to the insurance company...

Question 5

You are considering the purchase of one ticket for a raffle with a grand prize of $1,000. There are two prizes worth $100 and five prizes worth $20. If you know that only 100 tickets will be sold, what is the most you would pay for one raffle ticket?

Accepted Answer

The answer of You are considering the purchase of one...

Question 6

Warranties that cover the cost of a repair or replacement will:

Accepted Answer

Warranties that cover the cost of a repair or replacement increase the consumer's expected utility from consuming the good because they provide assurance that any defects or issues with the product will be resolved at no additional cost. This can increase the consumer's satisfaction with the purchase and their overall utility from the good.

Question 7

Use the following to answer question: 
-(Table: Crop Income) Look at the table Crop Income. Brent is a farmer, and his income depends on the weather.A) Calculate Brent's expected income.
B) Calculate Brent's expected utility.

Accepted Answer

The answer of Use the following to answer question: 
-(Table:...

Question 8

Most college-bound high school seniors apply for admission to several colleges of varying reputations and admission standards. Explain how this behavior is similar to diversification of assets discussed in the chapter.

Accepted Answer

The answer of Most college-bound high school seniors apply for...

Question 9

Newman has decided to take a road trip in a rental car. He has the minimum amount of personal car insurance to rent the car, but he decides to pay a little extra to the rental car company to completely insure himself against any damage to the rental car. How is there a potential moral hazard due to Newman's purchase of the additional insurance?

Accepted Answer

The answer of Newman has decided to take a road...

Question 10

You own a shoe store and need a new sales associate. You have a large stack of applications, but unfortunately you have no idea who is a strong salesperson and who is a weak one. What kind of problem are you facing and how can you solve it?

Accepted Answer

The answer of You own a shoe store and need...

Question 11

Use the following to answer questions:
Scenario: Health Costs
Alan is hoping for a healthy year, meaning that he would have zero health costs. Given his habits, there is a 40% chance that Alan will develop a health issue resulting in $50,000 in health costs. Assume these are the only two conditions that could exist for Alan in the coming year.
-(Scenario: Health Costs) Look at the scenario Health Costs. When Alan's probability of developing a health problem decreases, holding everything else constant, Alan's expected value of health care costs:

Accepted Answer

When the probability of developing a health problem decreases, the expected value of health care costs decreases because the expected value is calculated as the probability of the event occurring multiplied by the cost associated with that event.

Question 12

Lucy decides to buy car insurance because:

Accepted Answer

Lucy buys car insurance to decrease her exposure to risk by transferring the financial risk of potential car-related incidents to the insurance company.

Question 13

Use the following to answer questions:
Scenario: Health Costs
Alan is hoping for a healthy year, meaning that he would have zero health costs. Given his habits, there is a 40% chance that Alan will develop a health issue resulting in $50,000 in health costs. Assume these are the only two conditions that could exist for Alan in the coming year.
-(Scenario: Health Costs) Look at the scenario Health Costs. Suppose that Alan decides to change his habits dramatically and as a result decreases the probability of his developing a health problem such that he now has a 20% chance of becoming ill. What is the expected value of Alan's health costs now?

Accepted Answer

The answer of Use the following to answer questions:
Scenario: Health...

Question 14

Suppose for the coming year a family has calculated its expected value for car repairs to be $3,000. The family decides to buy a car insurance policy that would cover such claims. This insurance policy would cost a total of $3,000 for the household. This insurance policy is:

Accepted Answer

A fair insurance policy is one where the premium equals the expected value of the claims, which in this case is $3,000.

Question 15

Risk-averse individuals:

Accepted Answer

Risk-averse individuals are willing to pay higher insurance premiums to reduce their risk, making choice B the correct answer. They may still gamble, but are less likely to do so since they value security over the chance of winning, making choice A incorrect. Risk-averse individuals are not necessarily a minority of the population, making choice C incorrect. They have downward-sloping marginal utility functions, as additional units of wealth become less and less valuable to them as they accumulate more wealth, making choice D incorrect.

Question 16

When Lloyd's of London offered to provide insurance to merchant ships in the eighteenth century, Lloyd's was:

Accepted Answer

Lloyd's of London was willing to take on the risk of insuring merchant ships, indicating they were less sensitive to risk compared to the merchants who sought insurance to mitigate their own risk exposure.

Question 17

Organized-gambling venues such as those at Las Vegas tend to attract:

Accepted Answer

Organized-gambling venues tend to attract people who may be irrational in their choice of gambling and are often risk-averse because they believe they have a chance to win big despite the odds being against them. This is one of the reasons why casinos make a lot of money.

Question 18

An individual finds that as his income increases, his total utility also increases but at a decreasing rate. This can be attributed to:

Accepted Answer

As income increases, the additional satisfaction (marginal utility) gained from each additional unit of income decreases, which is the principle of diminishing marginal utility.

Question 19

Jaleh has just landed a great job and plans to buy a fancy car worth $100,000. Jaleh is otherwise risk-averse, but she likes to drive fast, so the probability that she wrecks the car (a total loss of $100,000) is 0.1. The probability that she has no accidents is 0.9. If an insurance company were to offer Jaleh a fair insurance policy that completely replaced her car, how much would she pay? What is the most she would pay for an insurance policy that would completely replace her car if she totaled it?

Accepted Answer

The answer of Jaleh has just landed a great job...

Question 20

The seller of a product will sometimes offer a warranty that if the product is defective, the seller will repair or replace it free of charge within a specified time. What is the role of product warranties in lessening the problem of asymmetric information (or private information) and increasing the number of transactions that are made?

Accepted Answer

The answer of The seller of a product will sometimes...

Quiz 20: Uncertainty, Risk, and Private Information