Question 1

Pascal is risk-averse while Marion is risk-neutral. Both are confronted with the following gamble: win $5,000 with the probability of 65 percent or lose $9,000 with a probability of 35 percent. One can predict that:

Accepted Answer

The expected value of this gamble is $100 = (0.65)($5,000)+ (0.35)(-$9,000). Since the expected value of this gamble is positive, Marion will definitely accept the gamble and Pascal might accept the gamble.

Question 2

Consider the gamble inherent in looking for an apartment. If the expected value of going to see another apartment is zero, then

Accepted Answer

If the expected value is zero, a risk-averse person will not see the next apartment. A risk-averse person will refuse any fair gamble.

Question 3

Obi-Wan is considering whether to buy a lightsaber. With probability 0.50 he will value the lightsaber at $4,000, and with probability 0.50 he will value it at $1,000. If new lightsabers sell for $2,500, then buying a new lightsaber is a:

Accepted Answer

For Obi-Wan, buying a lightsaber is a gamble with an expected value of (0.50 × $4,000)+ (0.50 × $1,000)- $2,500 = $0. Since the expected value of this gamble is zero, it is a fair gamble.

Question 4

Suppose Chris is offered the following gamble:  with probability 0.1 he will win $90, with probability 0.4 he will win $50, and with probability 0.5 he will lose $60. The expected value of this gamble is ________.

Accepted Answer

(0.1)($90)+ (0.4)($50)+ (0.5)(-$60)= -$1.

Question 5

Curly is offered the following gamble: a 25 percent chance of winning $1,500 and a 75 percent chance of losing $500. This is a(n):

Accepted Answer

The expected value of this gamble is: $0 = (0.25)($1,500)+ (0.75)(-$500). Since the expected value of this gamble is zero, it is a fair gamble.

Question 6

A risk-averse individual will:

Accepted Answer

A risk-averse person will only accept better-than-fair gambles. They will refuse any fair gamble.

Question 7

A risk-neutral individual will:

Accepted Answer

A risk neutral person will only accept gambles that are fair or better-than-fair (that is, gambles with an expected value of zero or greater than zero).

Question 8

Lou and Toby both live in a little town and are trying to sell their cars. Both of their cars have a blue book value of $10,000. Lou has an American car like most of the people in town own. Toby owns the only Bulgarian car in town. If people in their town are risk averse, then who will get closest to the blue book value for his car?

Accepted Answer

Given that most of the people in town own an American car, there will be less uncertainty about the quality of Lou's car. This will make risk-averse people prefer Lou's car over Toby's car.

Question 9

Mel is thinking of going on a cruise. Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50. The probability of nice weather is 60 percent and the probability of bad weather is 40 percent. Trip insurance is sometimes available. If purchased, it allows travelers to delay the cruise until the weather is nice. Suppose that the price of the cruise is $1,200. If Mel is risk-neutral, then Mel should:

Accepted Answer

In the absence of trip insurance, the expected value of the cruise is  $20 = (0.60)($2,000)+ (0.40)($50)- $1,200. With trip insurance, the expected value of the cruise is $800 = $2,000 - $1,200. Thus, if Mel is risk neutral, then she would be willing to pay up to $780 for trip insurance.

Question 10

Mel is thinking of going on a cruise. Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50. The probability of nice weather is 60 percent and the probability of bad weather is 40 percent. Trip insurance is sometimes available. If purchased, it allows travelers to delay the cruise until the weather is nice. The amount of money that Mel is willing to pay for trip insurance will be:

Accepted Answer

If Mel is risk-averse instead of risk-neutral, then she will be willing to pay more to avoid the uncertainty about the weather.

Question 11

Suppose Chris is offered the following gamble:  with probability 0.1 he will win $90, with probability 0.4 he will win $50, and with probability 0.5 he will lose $60. The expected value of this gamble is found by solving:

Accepted Answer

The expected value of a gamble is the sum of all the possible outcomes multiplied by their respective probabilities.

Question 12

Suppose Vinnie is looking for a month-long vacation rental in San Diego. The first vacation rental Vinnie finds costs $800 per month. If he looks for another vacation rental, there's a 75 percent chance he'll find another one for $800 per month and a 25 percent chance he'll find one for $600 per month. Other than price, all of the vacation rentals are identical. Vinnie's marginal cost of searching for an additional vacation rental is $45. For Vinnie, the expected value of searching for another vacation rental is:

Accepted Answer

If Vinnie searches for another vacation rental, there's a 75 percent chance he'll find another one that's the same price and a 25 percent chance he'll save $200. Thus, the expected value of search is: $5 = (0.75)($0)+ (0.25)($200)- $45.

Question 13

Obi-Wan is considering whether to buy a lightsaber. With probability 0.50 he will value the lightsaber at $4,000, and with probability 0.50 he will value it at $1,000. If Obi-Wan is risk averse, then he will be willing to pay ________ for a new lightsaber.

Accepted Answer

For Obi-Wan, the expected value of buying a lightsaber is (0.50 × $4,000)+ (0.50 × $1,000)= $2,500, so if Obi-Wan is risk averse, then he will be willing to pay less than $2,500 for it.

Question 14

Suppose someone offers Max the following gamble: with probability 0.50 he will win $10 and with probability 0.50 he will lose $8. The expected value of this gamble is:

Accepted Answer

The expected value of this gamble is $1 = (0.50)($10)+ (0.50)(-$8).

Question 15

Suppose Mo is considering whether to see Zombie Revenge III at her local movie theater. Tickets cost $12 each, but Mo isn't sure how much she's going to like the movie. There's a 40 percent chance she'll get $20 worth of enjoyment from seeing the movie, and there's a 60 percent chance she'll only get $10 worth of enjoyment from seeing the movie. Mo's expected value of seeing the movie is:

Accepted Answer

The expected value of seeing the movie is $2 = (0.40)($20)+ (0.60)($10)- $12.

Question 16

Suppose Chris is offered the following gamble: with probability 0.1 he will win $90, with probability 0.4 he will win $50, and with probability 0.5 he will lose $60. Chris will:

Accepted Answer

A risk-neutral person will only accept a gamble if it is fair or better-then-fair. Since the expected value of this gamble is less than zero, no risk-neutral person would accept this gamble.

Question 17

Mel is thinking of going on a cruise. Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50. The probability of nice weather is 60 percent and the probability of bad weather is 40 percent. Trip insurance is sometimes available. If purchased, it allows travelers to delay the cruise until the weather is nice. If Mel is risk-neutral, then in the absence of trip insurance, the most she will be willing to pay for the cruise is:

Accepted Answer

The expected benefit of going on the cruise is $1,220 = (0.60)($2,000)+ (0.40)($50). Because Mel is risk-neutral, she will only take gambles in which the expected value is greater than or equal to 0, so he would never pay more than the expected benefit of $1,220.

Question 18

Suppose Vinnie is looking for a month-long vacation rental in San Diego. The first vacation rental Vinnie finds costs $800 per month. If he looks for another vacation rental, there's a 75 percent chance he'll find another one for $800 per month and a 25 percent chance he'll find one for $600 per month. Other than price, all of the vacation rentals are identical. Vinnie's marginal cost of searching for an additional vacation rental is $45. Since searching for another apartment is a ________ gamble, if Vinnie is risk-neutral, then he ________ search for another apartment.

Accepted Answer

The expected value of search is: $5 = (0.75)($0)+ (0.25)($200)- $45. Since this is greater than zero, we know that searching is a better-than-fair gamble, and a risk-neutral person will accept any better-than-fair gamble.

Question 19

A 65 percent chance of winning $10 and a 35 percent chance of losing $5 would be classified as a(n)

Accepted Answer

This would be a better-than-fair gamble because the expected value of the gamble is $4.75 = (0.65)($10)+ (0.35)($5), which is greater than zero.

Question 20

Cal has a choice between two gambles. The first gamble offers a 50 percent chance of winning $20 and a 50 percent chance of losing $20. The second gamble offers a 20 percent chance of winning $100 and an 80% chance of losing $20. Which choice has the higher expected value?

Accepted Answer

The expected value of the first gamble is $0 (= 0.50 × $20 - 0.50 × $20).  The expected value of the second gamble is $4 (= 0.20 × $100 - 0.80 × $20).

Quiz 12: The Economics of Information