ECO 301 TEST BANK FOR CHAPTER 4 Uncertainty Graded with all answers correct

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ECO 301 TEST BANK FOR CHAPTER 4 Uncertainty 1. Probability is sometimes defined as 2. Expected value is defined as 3. If a fair gamble is played many... times, the combined monetary losses or gains will 4. People who choose not to participate in fair gambles are called 5. A gamble can be described as “fair” if the expected value of the gamble (including any costs of play) is 6. Risk aversion is best explained by 7. An individual will never buy complete insurance if 8. With moral hazard, fair insurance contracts are not viable because 9. Risk averse individuals will diversify their investments because this will 10. Suppose a lottery ticket costs $1 and the probability that a holder will win nothing is 90%. What must the jackpot be for this to be a fair bet? 11. Suppose a lottery ticket costs $1 and the probability that a holder will win nothing is 99%. What must the jackpot be for this to be a fair bet? 12. Suppose a lottery ticket costs $1 and the probability that a holder will win nothing is 99.9%. What must the jackpot be for this to be a fair bet? 13. Suppose a lottery ticket costs $1and has a jackpot of $1,000. What must the probability of winning nothing be if the bet is fair? 14. Suppose a lottery ticket costs $1and has a jackpot of $1 million. What must the probability of winning nothing be if the bet is fair? 15. Suppose a family has saved enough for a 10 day vacation (the only one they will be able to take for 10 years) and has a utility function U = V1/2 (where V is the number of healthy vacation days they experience). Suppose they are not a particularly healthy family and the probability that someone will have a vacation-ruining illness (V = 0) is 20%. What is the expected value of V? 16. Continuing with the family from the preceding question, what is their expected utility? 17. Continuing with the same family from the preceding question, what is the greatest (integer) number of vacation days the family would be willing to give up in order to guarantee a healthy vacation? 18. Continuing with the same family from the preceding question, suppose a risk neutral insurance company exists to provide vacation insurance. Suppose further that each vacation day requires a constant expenditure, and this expenditure is standard across everybody. This allows us to simplify the problem by considering all payments to be in terms of vacation days. What is the least the insurance company would charge (in terms of vacation days)? 19. Continuing with the same vacation-insurance company from the preceding question, what vacation-day price(s) would be acceptable to both the family and the insurance company? 20. Continuing with the same vacation-insurance company from the preceding question, is there any vacation-day price that would both strictly increase the family’s expected utility (compared to no insurance) and strictly increase the profits of the risk-neutral insurance company? 21. Suppose a family has saved enough for a 10 day vacation (the only one they will be able to take for 10 years) and has a utility function U = V1/2 (where V is the number of healthy vacation days they experience). Suppose they are not a particularly healthy family and the probability that someone will have a vacation ruining illness (V = 0) is 30%. What is the expected value of V? 22. Continuing with the family from the preceding question, what is their expected utility? 23. Continuing with the same family from the preceding question, what is the greatest (integer) number of vacation days the family would be willing to give up in order to guarantee a healthy vacation? 24. Continuing with the same family from the preceding question, suppose a risk neutral insurance company exists to provide vacation insurance. Suppose further that each vacation day requires a constant expenditure, and this expenditure is standard across everybody. This allows us to simplify the problem by considering all payments to be in terms of vacation days. What is the least the insurance company would charge (in terms of vacation days)? 25. Continuing with the same vacation-insurance company from the preceding question, what vacation-day price(s) would be acceptable to both the family and the insurance company? 26. Continuing with the same vacation-insurance company from the preceding question, is there any vacation-day price that would both strictly increase the family’s expected utility (compared to no insurance) and strictly increase the profits of the risk-neutral insurance company? 27. Suppose a risk-neutral power plant needs 10,000 tons of coal for its operations next month. It is uncertain about the future price of coal. Today it sells for $60 a ton but next month it could be $50 or $70 (with equal probability). How much would the power plant be willing to pay today for an option to buy a ton of coal next month at today’s price? (Ignore discounting over the short period of a month.) 28. Continuing with the power plant from the previous question, suppose instead the price of coal next month could be $54 or $66 (with equal probability). Now how much would it be willing to pay for an option to buy a ton of coal oil next month at today’s price? 29. Continue with the power plant from the previous question, where again coal currently sells for $60 a ton but will sell for either $54 or $66 next month with equal probability. Now suppose coal can be stored for a month at the cost of $2 per ton. How would the new alternative of being able to buy coal at today’s prices and store it affect the amount the power plant would be willing to pay for an option to buy coal next month at today’s prices? [Show More]

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