Principles of Economics, 7th Edition (MindTap Course List)
7th Edition
ISBN: 9781285165875
Author: N. Gregory Mankiw
Publisher: Cengage Learning
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Chapter 22, Problem 2QCMC
To determine
The example of moral hazard.
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In the summer of 1984, Nicholai opened a
small art gallery in the West Village and
amassed a collection worth $2,60,000. An
insurance company figured there was a 5%
chance the collection would be destroyed and
worth $0. Nicholai has utility u(x) = x0.5. If
Nicholai purchases full insurance at a fair
price, his expected utility would be ___.
while if he declines the insurance he would
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b. 1,487.5; 1,444.9
с. 1,571.6;B 1,531.8
d. 1,571.6; 1,444.9
You have a car valued at Gh60, 000. You estimate that there is a 0.1 percent chance that your car will be stolen. An insurance company offers you insurance against this eventuality for a premium of Gh800. If you are risk-neutral, should you buy insurance?
An individual has 40,000 in income per year. The person will get sick with probability 0.1. If he
does get sick, the medical bills will total 30,000. The following tables shows the utility derived
from certain amounts of income:
Income Utility
40,000 200
|37,000 195
35,000 190
30,000 170
|20,000 140
10.000 100
A. Is this person risk neutral, risk loving or risk averse? Why?
B. Considering the probability of illness, what is the expected income without
insurance? Show your work.
Chapter 22 Solutions
Principles of Economics, 7th Edition (MindTap Course List)
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- Why do economists say that people tend to be risk-averse?arrow_forwardpart c, d, and e pleasearrow_forward1)Describe an example of moral hazard that we may run into in the real world. Think of something that is legal and not inherently lethal, yet still demonstrates elevated risk for the participant who would likely act safer if insurance or protection was not available. Explain why someone might take this risky action. What are the benefits to the risky behavior? In your response to two of your peers, explain what an insurance company may do to reduce the likelihood that an individual would take this risk. Keep in mind, that we cannot always just deny coverage if an individual is participating in the risky behavior.arrow_forward
- 1. Mel is thinking of going on a cruise. Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50. The probability of nice weather is 60 percent and the probability of bad weather is 40 percent. Trip insurance is sometimes available. If purchased, it allows travelers to delay the cruise until the weather is nice. Suppose that the price of the cruise is $1,200. If Mel is risk-neutral, then Mel should: not buy trip insurance. only buy trip insurance if it costs less than $780. only buy trip insurance if it costs less than $20. only buy trip insurance if it costs less than $50. 2. Several web sites, like Pricewatch.com, allow consumers to input the name of a product, and the site then returns a list of suppliers with their respective prices for the product. This: increases the benefit of search.. increases the free-rider problem. reduces the benefit of search. reduces the cost of search.arrow_forwardpart a and b pleasearrow_forwardPlease do a iv, and b i and iiarrow_forward
- 4arrow_forward1. Suppose a person's utility is equal to U = Y and the initial income is $80,000. Medical expenses for a sick person amount to $40,000 and the probability of getting sick is 25%. Assume that the individual is required to pay the actuarially fair premium (r = p * M). a. b. What is the expected income when you are healthy? When you are sick? What is the expected utility if you buy insurance? What is the expected utility without insurance? C. What is the actuarially fair premium for the individual? d. Graph the individual's utility function. Clearly indicate the expected disposable income, utility with insurance, and expected utility without insurance. What is the dollar value of the individual's risk premium? Show this on the graph. How much is the individual willing to pay for insurance? e. f.arrow_forwardHow might adverse selection make it difficult for an insurance market to operate?arrow_forward
- Select the correct answer(s) for each item. If NONE or MORE THAN ONE of the choices is the correct answer, choose E.arrow_forwardSuppose that a person's utility function is the square root of wealth. Suppose the person earns $100,000 per year. He or she has an illness with a probability of 0.2, and the cost of the treatment is $30,000. Would the person pay $6,000 for insurance? Why or why not? What is the most this person would pay to be insured (hint: equate expected utility to utility with certainty)? Suppose their utility function changed to wealth squared (hint: are they now risk averse?). Would they pay $6,000 for insurance? Why or why not?arrow_forwardWhat is moral hazard?arrow_forward
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