Question 1

Risk aversion helps to explain various things we observe in the economy, including

Accepted Answer

Risk aversion is a phenomenon where individuals prefer a guaranteed outcome over a risky one with the same expected value. This behavior can explain why people follow the old adage of not putting all eggs in one basket, as it reduces the risk of losing all assets. Similarly, individuals opt for insurance to protect themselves from financial losses in case of unforeseen events. The risk-return trade-off states that higher the risk, the higher is the potential return. However, risk-averse individuals may not take on higher risks and opt for lower returns with less risk. All these observations are explained by the concept of risk aversion.

Question 2

Suppose the parents of a child born in the year 2000 had invested $5,000 at a 10% interest rate to be paid out to the child when she turns 21 years old. Approximately how many times will the investment double by the time it is paid out to the child?

Accepted Answer

The investment period is 21 years, and an investment of $5,000 at a 10% interest rate would double approximately every 7 years according to the rule of 72 (72/10 = 7.2). Therefore, the investment would double 3 times over 21 years.

Question 3

If Joanna is risk averse, then

Accepted Answer

Risk aversion means that someone dislikes bad things more than they like comparable good things, which is reflected in their utility function. Options A and B do not properly describe risk aversion, and option D is false as many individuals exhibit some degree of risk aversion.

Question 4

Diminishing marginal utility of wealth implies that the utility function

Accepted Answer

Diminishing marginal utility of wealth means that the more wealth a person has, the less additional utility or satisfaction they will receive from an additional unit of wealth. This implies a decreasing slope for the utility function. Additionally, a person who experiences diminishing marginal utility of wealth is likely to be risk averse and prefer a lower-risk option that offers a guaranteed return rather than a higher-risk option that offers the potential for a higher return. Therefore, the correct choice is C, which indicates a decreasing slope and a person who is risk averse.

Question 5

Figure 27-1. The figure shows a utility function. 
-Refer to Figure 27-1. Which distance along the vertical axis represents the marginal utility of an increase in wealth from $600 to $800?

Accepted Answer

The marginal utility of an increase in wealth from $600 to $800 is represented by the slope of the line between points B and C. Therefore, the distance between point B and point C represents the change in wealth and the corresponding change in marginal utility.

Question 6

Risk aversion helps to explain various things we observe in the economy, including

Accepted Answer

All three options - adherence to diversification, insurance, and the risk-return trade-off - are explained by risk aversion. People tend to be risk-averse, which leads them to spread out their investments (diversification), purchase insurance to protect against potential losses, and demand higher returns for taking on greater risk.

Question 7

Suppose you win the lottery and one of your payment options is to receive $20,000 today, $20,000 one year from now, and $20,000 two years from now. If the interest rate is 5%, what is the present value of this option?

Accepted Answer

The answer of Suppose you win the lottery and one...

Question 8

Figure 27-1. The figure shows a utility function. 
-Refer to Figure 27-1. What is measured along the vertical axis?

Accepted Answer

The vertical axis in the figure represents utility, which is a measure of satisfaction or well-being. Therefore, the best choice(s) would be based on maximizing utility, which can be found at the point where the budget constraint (shown as the diagonal line) is tangent to the highest possible indifference curve. This point represents the optimal combination of goods that provides the highest level of satisfaction for the given budget.

Question 9

For a risk averse person,

Accepted Answer

Risk averse individuals prefer avoiding losses over acquiring gains. Therefore, the pain of losing $1,000 on a bet exceeds the pleasure of winning $1,000 on a bet.

Question 10

Suppose Emilio offers you $500 today or $X in 10 years. If the interest rate is 6 percent, then at what value of X would you be indifferent between the two options?

Accepted Answer

The answer of Suppose Emilio offers you $500 today or...

Question 11

Figure 27-1. The figure shows a utility function. 
-Refer to Figure 27-1. Let 0A represent the distance between the origin and point A; let AB represent the distance between point A and point B; etc. Which of the following ratios best represents the marginal utility per dollar when wealth increases from $400 to $600?

Accepted Answer

The answer of Figure 27-1. The figure shows a utility...

Question 12

Economists have developed models of risk aversion using the concept of

Accepted Answer

Economists typically model risk aversion using the concept of utility, which represents the satisfaction or happiness a person gets from consuming goods and services. Risk aversion refers to the tendency of people to prefer less risky choices over more risky ones, even if the expected outcomes are the same. The assumption of diminishing marginal utility means that as a person consumes more of a certain good or service, the additional satisfaction they get from each additional unit consumed decreases. This is a standard assumption in economics and underlies the concept of risk aversion.

Question 13

Figure 27-1. The figure shows a utility function. 
-Refer to Figure 27-1. The utility function that is shown exhibits the property of diminishing

Accepted Answer

The utility function exhibited in Figure 27-1 shows diminishing marginal utility, as the curve becomes flatter as quantity increases, indicating that each additional unit of the good provides less additional utility.

Question 14

Figure 27-1. The figure shows a utility function. 
-Refer to Figure 27-1. Suppose the person to whom this utility function applies begins with $600 in wealth. Starting from there,

Accepted Answer

The answer of Figure 27-1. The figure shows a utility...

Question 15

Matt's Utility Function  If Matt's current wealth is $51,000, then

Accepted Answer

The answer of Matt's Utility Function  If Matt's current...

Question 16

You receive $2,000 today which you plan to save for 15 years. If the interest rate is 4 percent, what is the future value of this $2,000?

Accepted Answer

The formula for future value with compound interest is: 
FV = PV x (1 + r)^n 
Where FV is the future value, PV is the present value, r is the interest rate, and n is the number of periods.

Using this formula, we can calculate the future value of $2,000 after 15 years at 4% interest: 
FV = $2,000 x (1 + 0.04)^15 
FV = $2,000 x 1.749 
FV = $3,498

Therefore, the closest answer choice is C: $3,601.89

Question 17

David's Utility Function  If David's current wealth is $61,000, then

Accepted Answer

The answer of David's Utility Function  If David's current...

Question 18

Suppose you purchase a savings bond today for $25. In seven years you may cash in the savings bond for $50. What is the approximate interest rate paid by the savings bond?

Accepted Answer

The bond doubles in value over a seven year period, which means it has an annual growth rate of approximately 10%. To calculate this, divide the ending value of $50 by the initial cost of $25 and take the seventh root of the result: (50/25)^(1/7) ≈ 1.099 or 10.0%. Therefore, the interest rate paid by the savings bond is approximately 10%.

Question 19

Figure 27-1. The figure shows a utility function. 
-Refer to Figure 27-1. For the person to whom this utility function applies,

Accepted Answer

The figure shows a diminishing marginal utility curve, which means that the more wealth the person has, the less utility they get from an additional dollar of wealth. Therefore, choice A is correct. The other choices cannot be determined from the information given.

Question 20

If you deposit $1,000 into a savings account that pays you 5% interest per year, approximately how long will it take to double your money?

Accepted Answer

The answer of If you deposit $1,000 into a savings...

Quiz 27: The Basic Tools of Finance

Risk aversion helps to explain various things we observe in the economy, including

Suppose the parents of a child born in the year 2000 had invested $5,000 at a 10% interest rate to be paid out to the child when she turns 21 years old. Approximately how many times will the investment double by the time it is paid out to the child?

If Joanna is risk averse, then

Diminishing marginal utility of wealth implies that the utility function

Figure 27-1. The figure shows a utility function. -Refer to Figure 27-1. Which distance along the vertical axis represents the marginal utility of an increase in wealth from $600 to $800?

Risk aversion helps to explain various things we observe in the economy, including

Suppose you win the lottery and one of your payment options is to receive $20,000 today, $20,000 one year from now, and $20,000 two years from now. If the interest rate is 5%, what is the present value of this option?

Figure 27-1. The figure shows a utility function. -Refer to Figure 27-1. What is measured along the vertical axis?

For a risk averse person,

Suppose Emilio offers you $500 today or $X in 10 years. If the interest rate is 6 percent, then at what value of X would you be indifferent between the two options?

Economists have developed models of risk aversion using the concept of

Figure 27-1. The figure shows a utility function. -Refer to Figure 27-1. The utility function that is shown exhibits the property of diminishing

Figure 27-1. The figure shows a utility function. -Refer to Figure 27-1. Suppose the person to whom this utility function applies begins with $600 in wealth. Starting from there,

Matt's Utility Function If Matt's current wealth is $51,000, then

You receive $2,000 today which you plan to save for 15 years. If the interest rate is 4 percent, what is the future value of this $2,000?

David's Utility Function If David's current wealth is $61,000, then

Suppose you purchase a savings bond today for $25. In seven years you may cash in the savings bond for $50. What is the approximate interest rate paid by the savings bond?

Figure 27-1. The figure shows a utility function. -Refer to Figure 27-1. For the person to whom this utility function applies,

If you deposit $1,000 into a savings account that pays you 5% interest per year, approximately how long will it take to double your money?