EC248 Final Exam With Verified Solutions

EC248 Final Exam With Verified Solutions. - answerChapter 7 - risk because there is a fear of the unknown - forfeiting income in good times to get money in bad times - answerDemand for Insurance U'(1)0, utility increases with income U''(1)0, marginal utility for income is declining - answerRisk Aversion - probability of sickness= P (between 0 and 1) - probability healthy= 1-p - Is= income if sick - IHIs= income if healthy E(I)= PIs + (1-P)U(IH) - answerUncertainty - P=1 - E(U)= U(Is)= Is - P=0 - E(U)=U(IH)= IH SEE GRAPH - answerProbability of Sickness - customer pays up front fee - r= insurance premium - if ill customer gets q- insurance pay out - sick: IH+q-r - healthy: Is+0-r - optimal: Is'=IH', full insurance with no uncertainty - answerHealth Insurance Contract - means that insurance is fair - r=pq, q=IH-Is - Sub in values to previous equations - answerActuarially Fair Insurance r= premium q= payout E(pi)= profit E(pi(p,q,r))= (1-p)r + p(r-q)= r-pq - answerInsurer Profits - perfectly competitive: E(pi)=0, r=pq - unfair: E(pi)0, rpq - answerFair and Unfair Insurance Is'=IH' q= IH-Is - answerFull Insurance - doesn't achieve state independence Is'IH' qIH-Is - answerPartial Insurance See Graphs - answerComparing Contracts - answerChapter 8 - incomplete information about the quality of a good - answerAsymmetric Info - asymmetric info - can't tell quality of good, 1 price - adverse selection, only low quality goods remain in the market therefore don't buy, market failure - answerLemons Problem - Buyers value cars 50% more than sellers - M= utility from other goods, X= quality of car Us= Xj+M, Ub= 3/2 Xj+M - car quality uniform distribution - will put car on market if PXj, buyers buy if 3/2E(Xj)P this is not possible therefore no cars sell - assumptions: buyers don't know true quality of car, buyers know sellers utility and distribution of cars, buyers know sellers withdraw highest quality cars - answerAkerlof Model - transaction that leaves all parties at least no worse off - answerPareto Improving Transaction - over supply of low quality goods, products or contracts that results - answerAdverse Selection