SOLVED

2Â Buying and Selling Risk 1) Buying insurance is similar to A) selling risk. B) irrationally avoiding life’s risks. C) being a free rider. D) buying risk. 2) Insurance works by A) eliminating risks. B) decreasing risks. C) pooling risks. D) changing the individual’s marginal utility of wealth. 3) Insurance works because A) all policyholders pay in according to risks and all then receive a pay out in return. B) all policyholders pay in according to risks and then receive a pay out only if they incur a loss. C) all policyholders pay in according to risks and nobody receives any pay out. D) only high risk policyholders pay in while everyone is entitled to a pay out. 4) You overhear the following in the hallway, “Everyone eventually dies, so how can a life insurance company make a profit? Isn’t it a losing battle? You will always have to pay the death benefit to your clients!” You know that life insurance companies can be profitable. This is because A) the premiums you pay on a life insurance policy are always more than any death benefit, so the insurance company always comes out ahead. B) older people with a greater probability of dying during the term of a policy are denied any death benefits. C) the insurance company collects more than enough in premiums today to cover expected benefits payable today. D) life insurance companies are notorious for cheating clients with “fine print” policy clauses. 5) Insurance is possible and can be profitable because of A) private information. B) adverse selection. C) moral hazard. D) risk aversion. 6) Jon is risk averse. When he buys insurance against all risks, A) he knows his wealth with certainty. B) his utility exceeds his expected utility. C) his wealth exceeds his expected wealth. D) all of the above 7) Many residents of the city of Adelphia drive without automobile insurance. Assuming that Adelphia is just like any other city and these are risk averse individuals, which of the following is most likely true? A) Economic models do not work. B) These people maximize wealth. C) The price of automobile insurance exceeds their maximum value of insurance. D) There are no automobile accidents or thefts in the city of Adelphia. 8) Dane has a car valued at $20,000 that gives him a utility of 80. There is a 5 percent chance that he will have an accident that will make his car worthless, in which case his utility will be zero. His utility from a wealth of $15,000 is 76. The maximum amount Dane will be willing to pay for insurance is A) $1,000. B) $3,000. C) $5,000. D) $15,000. 9) Dan has a car valued at $10,000 that gives him a utility of 50 units. There is a 10 percent chance that he will have an accident that will make his car worthless, in which case his utility will be zero. His utility from a wealth of $7,000 is 45 units. The maximum amount Dan will be willing to pay for car insurance is A) $1,000. B) $3,000. C) $7,000. D) zero. Â Wealth (dollars) Total utility 0 0 20,000 200 40,000 245 60,000 270 80,000 287 100,000 300 10) Beachcomber Beatrice spent her entire wealth of $100,000 to build a beach house on the Gulf of Mexico. There is a 10 percent chance that the house will be totally destroyed by a hurricane. Beatrice’s utility of wealth schedule is given in the table above. What is Beatrice’s expected wealth? A) $10,000 B) $50,000 C) $90,000 D) $100,000