Content quiz 3 Flashcards
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?
7
Probability is sometimes defined as
the relative frequency with which an event will occur
A gamble can be described as “fair” if the expected value of the gamble (including any costs of
play) is
Zero
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?
8
Risk aversion is best explained by
decreasing marginal utility of income
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.)
0
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?
1000
An individual will never buy complete insurance if
He or she is a risk-taker
With moral hazard, fair insurance contracts are not viable because
probabilities of loss are increased over what is expected
People who choose not to participate in fair gambles are called
risk-averse
