Indicate whether the statement is true, false, or unclear, and justify your answer.In some markets, adverse selection develops over time as customers learn about their own risk levels.
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Indicate whether the statement is true, false, or unclear, and justify your answer.
In some markets, adverse selection develops over time as customers learn about their own risk levels.
Adverse selection refers the situation where there is a lack of information (asymmetric information to the buyers and sellers) in the market before an economic transaction take place. Thus, adverse selection develops over time as customers learn more about the quality of the product and their own risk levels.
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- Fred wants to hire Barney to manage his retail store. Barney can apply a high level of effort (at a cost to him of $30), a medium level of effort (at a cost to him of $10), or a low level of effort (at a cost to him of $0). Fred's profits depend not only of the level of Barney's effort but also on the state of consumer demand. Fred believes that demand will be high with probability 50 percent (and therefore demand will be low with probability 50 percent). Fred has determined the following possible profit levels (before paying Barney) will occur depending on Barney's effort and the state of consumer demand: Demand low high effort low 20 40 medium 40 80 high 80 100 Of the choices below, what is the largest percentage range of profit provided to Barney that would ensure Barney would supply high effort? a. any percent greater than 75.00 percent (3/4). b. any percent greater than 66.66 percent (2/3). c. any percent greater than 50.00 percent (1/2).d. any…You need to hire some new employees to staff your startup venture. You know that potential employees are distributed throughout the population as follows, but you can't distinguish among them: Employee Value $30,000 $49,000 $68,000 $87,000 Probability 0.25 0.25 0.25 0.25 The expected value of hiring one employee is $ Suppose you set the salary of the position equal to the expected value of an employee. Assume that employees will not work for a salary below their employee value. The expected value of an employee who would apply for the position, at this salary, is $ Given this adverse selection, your most reasonable salary offer (that ensures you do not lose money) isSetup from Question 1) An expected utility maximiser owns a car worth £60 000 and has a bank account with £20 000. The money in the bank is safe, but there is a 50% probability that the car will be stolen. The utility of wealth for the agent is u(y) = In(y) and they have no other assets. Question 2)
- In the markets for used items, there is a natural inclination for adverse selection. This means- Only high quality items are sold.- All items are sold- Only low quality items are sold - A mix of high and low quality items are sold.Suppose job applicants are distributed uniformly from $5,000 to $75,000 in quality. Asymmetric information exists such that firms may only observe the distribution. If firms are willing to pay a wage premium of 50% more than the average quality, then the equilibrium wage in the labor market equals $15,000 $65,000 $10,000 None of the above.Suppose that every driver faces a 2% probability of an automobile accident every year. An accident will, on average, cost each driver $14,000. Suppose there are two types of individuals: those with $112,000.00 in the bank and those with $3,500.00 in the bank. Assume that individuals with $3,500.00 in the bank declare bankruptcy if they get in an accident. In bankruptcy, creditors receive only what individuals have in the bank. Assume that both types of individuals are only slightly risk averse. In this scenario, the actuarially fair price of full insurance, in which all damages are paid by the insurance company, is . Assume that the price of insurance is set at the actuarially fair price. At this price, drivers with $112,000.00 in the bank likely buy insurance, and those with $3,500.00 in the bank likely buy insurance. (Hint: For each type of driver, compare the price of insurance to the expected cost without insurance.) Suppose a state law has been passed…
- Suppose that every driver faces a 2% probability of an automobile accident every year. An accident will, on average, cost each driver $7,000. Suppose there are two types of individuals: those with $42,000.00 in the bank and those with $1,750.00 in the bank. Assume that individuals with $1,750.00 in the bank declare bankruptcy if they get in an accident. In bankruptcy, creditors receive only what individuals have in the bank. Assume that both types of individuals are only slightly risk averse. In this scenario, the actuarially fair price of full insurance, in which all damages are paid by the insurance company, is $ Assume that the price of insurance is set at the actuarially fair price. At this price, drivers with $42,000.00 in the bank likely v buy insurance, and those with $1,750.00 in the bank likely buy insurance. (Hint: For each type of driver, compare the price of insurance to the expected cost without insurance.) Suppose a state law has been passed forcing all individuals to…3.Which of the following statements is FALSE regarding the concept of "adverse selection"? Multiple Choice Adverse selection describes a situation where an individual's demand for insurance is positively correlated with the individual's risk of loss. Adverse selection occurs when someone increases their exposure to risk when insured. This can happen, for example, when a person takes more risks because someone else bears the cost of those risks. The relationship between smoking status and mortality provides a good illustration for adverse selection, especially in the case in which a life insurance company did not vary its premiums according to smoking status of its customers. To counter the effects of adverse selection, insurers may offer premiums that are proportional to a customer's risk.
- Shane just bought a house worth $360,000 in an area that is known for floods. A flood occurs with a 5% chance and if it occurs, his home is ✓ for reduced in value to $202,500. Shane has utility function given by U(X)=√√X. He would be willing to pay a maximum of flood insurance. The fair insurance premium for flood insurance is Shane's risk premium is Suppose, instead, that Shane's utility function is given by U(X) = X². Then, the maximum he would be willing to pay for flood insurance isThere are two types of drivers, safe types who have an annual probability of getting in an accident of 10% and risky types who get in a car crash with probability 20%. Each type represents half of the population. When a car crash occurs, it costs the insurance company $10,000. This problem is about asymmetric information, specifically in insurance markets. To answer this question, it helps to understand insurance. Insurance contracts work in the following way. The amount that the insurer pays in the event of an accident is Payout = (Accident cost - Deductible) *Coinsurance rate. The rest is paid by the individual. The expected value of a firm's expenses are E[Payout] = (probability of an accident)*Payout. The insurance premium is the price the consumer pays for insurance. It is paid regardless of whether there is an accident. Therefore, the insurer's expected profit = Premium - E[Payout]. a. Suppose the insurer offered only one type of contract: deductible=0 and coinsurance rate= 100%.…Priyanka has an income of £90,000 and is a von Neumann-Morgenstern expected utility maximiser with von Neumann-Morgenstern utility index . There is a 1 % probability that there is flooding damage at her house. The repair of the damage would cost £80,000 which would reduce the income to £10,000. a) Would Priyanka be willing to spend £500 to purchase an insurance policy that would fully insure her against this loss? Explain. b) What would be the highest price (premium) that she would be willing to pay for an insurance policy that fully insures her against the flooding damage?
