Question 1

Suppose 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 the probability of a major theft...

Question 2

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 3

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

People who are less sensitive to risk are willing to take on more risk and may therefore sell their risk to those who are willing to pay to reduce their risk. This allows for a more efficient allocation of risk, as those who are best suited to handle it take on more while those who are less able or inclined to take on risk can reduce their exposure. This ultimately lowers overall risk and can lead to mutual gains, as both parties benefit from the transaction.

Question 4

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 in Los Angeles
B) Barcelona; supply; lower than in Los Angeles
C) Los Angeles; demand; higher than in Barcelona
D) Los Angeles; supply; lower than in Barcelona

Accepted Answer

The statement mentions that Barcelona has a good public transportation system, which could lead to less demand for cars and therefore less demand for auto insurance. On the other hand, Los Angeles does not have a good public transportation system, leading to more demand for cars and more demand for auto insurance. Therefore, the demand for auto insurance is higher in Los Angeles than in Barcelona.

Question 5

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 funds that an insurance company may have to pay out in the event of a claim is known as the "capital at risk." This refers to the amount of money that an insurer could potentially lose if they have to pay out on a claim. The fair premium is the amount that the insurer charges to cover the cost of the policy, the total premium is the entire premium paid by the policyholder, and the deductible is the amount that the policyholder must pay out of pocket before the insurer will cover the rest of the claim. Therefore, the most accurate answer is B.

Question 6

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

The answer of An efficient market for risk, such as...

Question 7

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 8

Suppose 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 the wealth of buyers in the...

Question 9

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

The answer of As the premium for an insurance policy...

Question 10

Use the following to answer questions 
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.
-(Scenario: Buying Shares) Look at the scenario Buying Shares. The probability that Geordie will sustain a loss is _____ if he invests $1,000 in either Apple or Microsoft and is _____ if he invests $500 apiece in Apple and in Microsoft.
A) 40%; 40%
B) 40%; 16%
C) 80%; 20%
D) 40%; 80%

Accepted Answer

The probability of sustaining a loss if Geordie invests $1,000 in either Apple or Microsoft is 40% (given in the scenario). If he invests $500 apiece in both Apple and Microsoft, then the probability of sustaining a loss in both is the probability of sustaining a loss in Apple AND the probability of sustaining a loss in Microsoft. This is equal to 0.4 x 0.4 = 0.16, or 16%. Therefore, option B is the best choice as it minimizes the overall probability of sustaining a loss.

Question 11

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 12

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)...

Question 13

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 here is known as pooling, where risks are reduced by taking small shares in many independent events or by taking advantage of the predictability associated with large numbers of independent events. Floating refers to selling securities to the public, specializing refers to focusing on a specific area of expertise, and screening refers to the process of evaluating potential investments or borrowers.

Question 14

Which of the following is 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

Trade in risk can produce mutual gains is one of the fundamental principles of the insurance industry. It means that insurance companies help individuals and businesses transfer their risks to the insurer, who can spread the risk among many policyholders and reduce the cost of risk for each policyholder. This creates a win-win situation where both the insurer and insured parties benefit. The other options (B, C, and D) are not principles of the insurance industry. Diversification is a risk management strategy, deductibles can help reduce moral hazard, and adverse selection is a problem that insurance companies try to mitigate.

Question 15

Which of the following 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

If the insurance market is efficient, it should transfer risk from those who are most averse to it (i.e. those who want to get rid of it the most) to those who are least bothered by the risk. This is done through the pricing of premiums, as individuals who are at a higher risk of experiencing a loss will generally pay higher premiums. Deductibles may help to reduce moral hazard, but they do not eliminate it completely. Additionally, it is not necessarily true that society as a whole will engage in less risky behavior in an efficient insurance market. Premiums may be fair, but they will not always be at a specific level.

Question 16

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

As the premium for an insurance policy rises, there is a decrease in the quantity demanded of insurance. This is because higher premiums make insurance less affordable for consumers, leading to a decrease in the amount of insurance being purchased. However, the demand for insurance (which represents the overall desire or need for insurance) may still be high, depending on factors like the level of risk and uncertainty facing consumers. The supply of insurance is not directly affected by changes in premiums, but may be influenced by factors like the availability of capital and competition among insurers.

Question 17

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

Accepted Answer

The answer of The total amount of funds that potentially...

Question 18

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.

Question 19

Use the following to answer questions 
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.
-(Scenario: Buying Shares) Look at the 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.
A) 60%; 60%
B) 60%; 84%
C) 76%; 24%
D) 60%; 36%

Accepted Answer

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

Question 20

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

The devastating floods have increased the level of risk aversion among the insurance investors, which means that they are now more reluctant to offer flood insurance policies. This will cause a leftward shift in the supply of flood insurance, leading to an increase in equilibrium premiums (as the supply decreases) and a decrease in the quantity of insurance bought and sold (as the demand exceeds the reduced supply). Therefore, option C correctly describes the market outcome. Options A and D are not correct because they suggest a rightward shift in supply or demand, which would result in lower premiums and a greater quantity of insurance being sold. Option B is not correct because it suggests a leftward shift in demand, which does not align with the assumption that insurance investors are becoming more risk-averse.

Quiz 19: Uncertainty, Risk, and Private Information

Suppose 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:

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

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:

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:

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

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

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

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?

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:

Which of the following is a principle of the insurance industry?

Which of the following is TRUE if the insurance market is efficient?

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

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

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