Problem set for week 9

Question 1

1. Most people buy insurance because they
   a. are risk lovers
   b. enjoy the gamble
   c. are risk neutral
   d. are risk averse

Answer 1

D

Question 2

2. An indication that Insurance companies anticipate adverse selection is
   a. they do not require a deductible
   b. they do not classify clients into different risk types according to their claim
   history
   c. they classify clients into different risk types according to pre-existing
   conditions
   d. they do not require a co-payment

Answer 2

C

Question 3

3. The “lemons” problem is that
   a. cars of verifiable high quality are withheld from the used car market
   b. cars of verifiable low quality are withheld from the used car market
   c. cars of unverifiable high quality are withheld from the used car market
   d. cars of unverifiable low quality are withheld from the used car market

Answer 3

C

Question 4

4. Sam often forgets to lock his flat. The value he puts on his flat and all the possessions
   inside it is £100,000. Given Sam’s forgetfulness, the probability of a burglary is 30%. If his
   flat gets broken into, he faces a property loss of £10,000. What is his expected wealth?
   a. £80,000
   b. £87,000
   c. £97,000
   d. £99,000

Answer 4

C

Question 5

5. Samantha often forgets to lock her house. This has caused the probability of a burglary to
   be 30%. If her house gets broken into, she faces a property loss of £10,000. Otherwise she
   gets to keep her £10,000 worth of possessions. The value she puts on her house and its
   contents if there is no break-in is £100,000. If Samantha is offered full coverage for her
   house at £1,500, what is her expected wealth with the insurance policy?
   a. £80,000
   b. £87,000
   c. £97,000
   d. £98,500

Answer 5

D

Question 6

6. Individuals with homeowner’s insurance tend to be more forgetful about locking their
   possessions safely before heading out. This is an example of
   a. Adverse selection
   b. Moral hazard
   c. Screening
   d. None of the above

Answer 6

B

Question 7

7. You offer an extended warranty for your product that replaces the product if it fails. If the
   product typically fails 2% of the time,
   a. you should price the warranty at less than 2% of the product price
   b. you should price the warranty at exactly 2% of the product price
   c. you should price the warranty at more than 2% of the product price
   d. Cannot tell from this information

Answer 7

C

Question 8

Use the following setup for questions 8-9
Tom wants to avoid any accidents on the work floor of his factory. If an accident does occur,
it would cost him £500,000 in damages. Installing safety equipment would decrease the
probability of an accident occurring from 20% to 10%. However, the equipment costs £20,000
to install.
8. What is his expected loss from an accident after installing the safety equipment?
a. £20,000
b. £50,000
c. £100,000
d. £125,000

Answer 8

B

Question 8

9. Would Tom install the safety equipment?
   a. Yes because it costs him less than it is worth
   b. Yes because it costs him more than it is worth
   c. No because it costs him more than it is worth
   d. No because it costs him less than it is worth

Answer 8

A

Question 9

10. Banks are more willing to lend money to those who have a sizable amount of their own
    money at risk because
    a. They like lending to individuals who usually don’t need the money
    b. Those with their own money at risk are more likely to only propose viable
    projects to the bank.
    c. Borrowers with their own capital invested are more likely to make payments
    on any loan that is made.
    d. Both b&c

Answer 9

D