Michael Parkin
ISBN #9780133872279
12th Edition
839 Questions
Homework Questions
This section illustrates how individuals make decisions in the face of uncertainty by comparing expected wealth and expected utility. It shows that risk aversion, due to diminishing marginal utility of wealth, leads people to prefer sure outcomes over risky ones even when the expected wealth is the same. The cost of risk is quantified by finding the wealth level that provides equivalent utility in a risk-free scenario. Moreover, the text explores how insurance markets allow individuals to trade risk, and how asymmetric information gives rise to problems like adverse selection and moral hazard, which are mitigated through signaling and screening mechanisms.
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The figure shows Lee's utility of wealth curve. Lee is offered a job as a salesperson in which there is a 50 percent chance that she will make $\$ 4,000$ a month and a 50 percent chance that she will make nothing. a. What is Lee's expected income from taking this job? b. What is Lee's expected utility from taking this job? c. How much would another firm have to offer Lee with certainty to persuade her not to take the risky sales job? d. What is Lee's cost of risk?
Use the following data to work Larry lives in a neighborhood in which 20 percent of the cars are stolen every year. Larry's car, which he parks on the street overnight, is worth $\$ 20,000$ (This is Larry's only wealth.) The table shows Larry's utility of wealth schedule. If Larry cannot buy auto theft insurance, what is his expected wealth and his expected utility?
Use the following data to work Larry lives in a neighborhood in which 20 percent of the cars are stolen every year. Larry's car, which he parks on the street overnight, is worth $\$ 20,000$ (This is Larry's only wealth.) The table shows Larry's utility of wealth schedule. High-Crime Auto Theft, an insurance company, offers to sell Larry insurance at $\$ 8,000$ a year and promises to provide Larry with a replacement car worth $\$ 20,000$ if his car is stolen. Is Larry willing to buy this insurance? If not, is he willing to pay $\$ 4,000$ a year for such insurance?
Suppose that there are three national soccer leagues: Time League, Goal Difference League, and Bonus for Win League. The leagues are of cqual quality, but the players are paid differently. Players in the Time League are paid by the hour for time spent practicing and playing. Players in the Goal Difference League are paid an amount that depends on the goals scored by the team minus the goals scored against it. Players in the Bonus for Win League are paid one wage for a loss, a higher wage for a tie, and the highest wage of all for a win. a. Describe the predicted differences in the quality of the games played by each of the leagues. b. Which league is the most attractive to players? c. Which league will generate the largest profits?
You can't buy insurance against the risk of being sold a lemon. Why isn't there such a market? How does the market provide a buyer with some protection against being sold a lemon? What are the main ways in which markets overcome the lemons problem?