Exam 17: Uncertainty and Asymmetric Information

You are in the market for a used 2013 Honda Accord. You know that half of the 2013 Accords are lemons and half are peaches. If you could be assured that the Accord you were buying was a peach, you would be willing to pay up to $10,000. On the other hand, you would only be willing to pay $2,000 for a lemon. You have no ability to discern whether any particular Accord is a lemon or a peach. Sellers of Accords, on the other hand, are likely to know whether their particular car is a lemon or a peach. Suppose sellers of lemons will sell their cars for $1,500 or more and peach sellers will be willing to sell their cars for $8,500 or more. Over time the price in the market for 2013 Accords will ________ and ________ will be traded.

In general, risk-averse individuals experience diminishing marginal utility from income.

A lender faces a(n) ________ problem when the lender lends funds to a borrower for a specific purpose and the borrower then opportunistically uses the funds for another purpose.

The ________ the utilities from each possible outcome of a situation weighted by the probability of that outcome is called expected utility.

Market signals are

Consider the following game. You pick a card from a standard 52-card deck and each time you select an ace, you get $520. For all other cards you must pay $26. This game is not a fair bet.

Refer to the data provided in Table 17.4 below to answer the following question(s). The table shows the relationship between income and utility for Celeste. Table 17.4 Income Total Utility \ 0 0 \ 40,000 50 \ 80,000 90 \ 120,000 120 \ 160,000 140 -Refer to Table 17.4. From the table, we can see that Celeste is

Refer to the data provided in Table 17.3 below to answer the following question(s). The table shows the relationship between income and utility for Terri. Table 17.3 Income Total Utility \ 0 0 \ 20,000 10 \ 40,000 25 \ 60,000 45 \ 80,000 75 -Refer to Table 17.3. Suppose Terri has a 25% chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Terri does not become disabled, she will earn her usual salary of $80,000. Terri has the opportunity to purchase disability insurance for $20,000 which will pay her her full salary in the event she becomes disabled. Terri's utility with the policy is ________ and her expected utility without the policy is ________.

Mechanism design is used to

Refer to the information provided in Figure 17.1 below to answer the question(s) that follow. Figure 17.1 -Refer to Figure 17.1. We would say that Dmitri is risk averse based on his

As a result, of adverse selection problems in the fire insurance market, it is likely that over time

A diagram of an individual's utility from income will be a line with an increasing slope if the individual is risk-averse.

Refer to the data provided in Table 17.2 below to answer the following question(s). The table shows the relationship between income and utility for Sue. Table 17.2 Income Total Utility \ 0 0 \ 20,000 20 \ 40,000 40 \ 60,000 60 \ 80,000 80 -Refer to Table 17.2. Sue earns $40,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Sue takes the bet, she will pick the Patriots. She believes that the Patriots have a 50-50 chance of winning the game. If the Patriots win, Sue will double her money ($80,000) but if they lose she loses her entire salary ($0). Sue's utility if she does not take the bet is ________ and her expected utility from the bet is ________.

Refer to the information provided in Figure 17.2 below to answer the question(s) that follow. Figure 17.2 -Refer to Figure 17.2. Sam has two job offers when he graduates from college. Sam views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $60,000. The second offer is at a fixed salary of $30,000 plus a possible bonus of $60,000. Sam believes that he has a 50-50 chance of earning the bonus. If Sam takes the offer that maximizes his expected utility and is risk-neutral, which job offer will he choose?

Refer to the information provided in Figure 17.1 below to answer the question(s) that follow. Figure 17.1 -Refer to Figure 17.1. John has two job offers when he graduates from college. John views the offers as identical, except for the salary terms. The first offer is at a fixed annual salary of $50,000. The second offer is at a fixed salary of $20,000 plus a possible bonus of $60,000. John believes that he has a 50-50 chance of earning the bonus. What is John's expected utility for each job offer?

Refer to the data provided in Table 17.5 below to answer the following question(s). The table shows the relationship between income and utility for Lucy. Table 17.5 Income Total Utility \ 0 0 \ 10,000 10 \ 20,000 20 \ 30,000 30 \ 40,000 40 -Refer to Table 17.5. Lucy earns $20,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Lucy takes the bet, she will pick the Packers. She believes that the Packers have a 50-50 chance of winning the game. If the Packers win, Lucy will double her money ($40,000) but if they lose she loses her entire salary ($0). Lucy's utility if she does not take the bet is

Refer to the data provided in Table 17.2 below to answer the following question(s). The table shows the relationship between income and utility for Sue. Table 17.2 Income Total Utility \ 0 0 \ 20,000 20 \ 40,000 40 \ 60,000 60 \ 80,000 80 -Refer to Table 17.2. Sue earns $40,000 annually. She has the opportunity to bet her entire salary on the upcoming super bowl. If Sue takes the bet, she will pick the Patriots. She believes that the Patriots have a 50-50 chance of winning the game. If the Patriots win, Sue will double her money ($80,000) but if they lose she loses her entire salary ($0). This bet can be characterized as

Refer to the data provided in Table 17.4 below to answer the following question(s). The table shows the relationship between income and utility for Celeste. Table 17.4 Income Total Utility \ 0 0 \ 40,000 50 \ 80,000 90 \ 120,000 120 \ 160,000 140 -Refer to Table 17.4. Suppose Celeste has a 1/3 chance of becoming disabled in any given year. If she does become disabled, she will earn $0. If Celeste does not become disabled, she will earn her usual salary of $120,000. Celeste has the opportunity to purchase disability insurance which will pay her her full salary in the event she becomes disabled. Such an insurance policy would be worth ________ to Celeste.

Refer to the data provided in Table 17.1 below to answer the following question(s). The table shows the relationship between income and utility for Jane. Table 17.1 Income Total Utility \ 0 0 \ 20,000 25 \ 40,000 45 \ 60,000 60 \ 80,000 70 -Refer to Table 17.1. From the table, we can see that Jane is

Refer to the Economics in Practice on page 360. Sometimes the lack of information in an advertisement serves as a signal.