Microeconomics, 14th Edition
by Michael Parkin
Complete Chapter Solutions Manual
are included (Ch 1 to 20)
** Immediate Download
** Swift Response
** All Chapters included
** Solutions Sheets
,Table of Contents are given below
Chapter 1 What is Economics?
Chapter 2 The Economic Problem
Chapter 3 Demand and Supply
Chapter 4 Elasticity
Chapter 5 Efficiency and Equity
Chapter 6 Government Actions in Markets
Chapter 7 Global Markets in Action
Chapter 8 Utility and Demand
Chapter 9 Possibilities, Preferences, and Choices
Chapter 10 Organizing Production
Chapter 11 Output and Costs
Chapter 12 Perfect Competition
Chapter 13 Monopoly
Chapter 14 Monopolistic Competition
Chapter 15 Oligopoly
Chapter 16 Public Choices, Public Goods, and Healthcare
Chapter 17 Externalities
Chapter 18 Markets for Factors of Production
Chapter 19 Economic Inequality
Chapter 20 Uncertainty and Information
,Solutions Manual organized in reverse order, with the last chapter
displayed first, to ensure that all chapters are included in this document.
(Complete Chapters included Ch20-1)
C h a p t e r 20 UNCERTAINTY
AND INFORMATION
Answers to the Review Quizzes
Page 476
1. What is the distinction between expected wealth and expected utility?
Expected wealth is the money value of what a person expects to own at a point in time. Expected utility is
the utility value of what a person expects to own at a point in time. These concepts both measure the value
of what a person expects to own at a point in time but they differ because expected wealth is the money
value and expected utility is the utility value.
2. How does the concept of utility of wealth capture the idea that pain of loss exceeds the
pleasure of gain?
The utility of wealth has diminishing marginal utility. Diminishing marginal utility means that the
decrease in utility from a dollar decrease in wealth, that is, the pain of loss, is greater than the increase in
utility from a dollar increase in wealth, that is, the pleasure of gain.
3. What do people try to achieve when they make a decision under uncertainty?
When making decisions under uncertainty people maximize their expected utility.
4. How is the cost of risk calculated when making a decision with an uncertain outcome?
A decision made with uncertainty has an expected wealth and an expected utility that depend on the
probability, wealth, and utility associated with the different outcomes. Because people are risk averse, the
amount of certain wealth that creates the utility equal to the expected utility in the uncertain case is less
than the expected wealth in the uncertain case. The difference between the expected wealth in the
uncertain case and the certain wealth that creates the same level of utility is the cost of risk.
Page 479
1. How does insurance reduce risk?
Insurance reduces the risk any individual faces because insurance pools risks. Everyone pays into the pool
but only the small fraction of people who suffer a loss are paid from the pool. Essentially people reduce the
risk of a large adverse financial outcome in exchange for the small, certain payment to the insurance
company.
2. How do we determine the value (willingness to pay) for insurance?
The amount that someone would be willing to pay to avoid risk is measured using the person’s utility of
wealth schedule or curve. The important feature of the curve is that the marginal utility of wealth
diminishes as wealth increases. The rate at which the marginal utility of wealth declines determines the
degree of the individual’s risk aversion, that is, how much he or she is willing to pay to avoid risk.
Suppose a person faces the risky situation of receiving wealth of W1 (with utility of U 1 ) or a smaller
amount, W2 (with utility of U 2 ). The expected wealth from this situation is EW, and the expected utility
is EU. This risky situation has the same utility as receiving some amount of certain wealth, W. The
difference in wealth between the risky high level of wealth and the sure case, W1 – W, measures the value
© 2023 Pearson Education, Inc.
, 276 CHAPTER 20
of insurance in this situation to this individual. The more rapidly the marginal utility of wealth declines,
the more risk averse is the person because the more wealth the individual is willing to give up to guarantee
a certain (albeit lower) amount of wealth. That is, the more concave the utility of wealth curve, the less is
the certain wealth that has the same utility as the expected utility from an uncertain, risky outcome.
3. How can an insurance company offer people a deal worth taking? Why do both the buyers and
the sellers of insurance gain?
Insurance companies work by pooling risks so that everyone pays into the pool but only the (small)
fraction of people who suffer a loss are paid from the pool. Although the likelihood of a bad occurrence is
small for each individual, for a large enough group the total number and total amount of losses can be
estimated very closely. The insurance company can calculate the size of the pool required to cover losses.
From this calculation the company can compute the amount of the premium each person must pay into
the pool to cover all the anticipated losses and other costs the company incurs. People buy insurance
because they are risk averse; they want to avoid unwanted outcomes. Insurance is worth buying because
people are willing to give up a relatively small amount of income all the time to guarantee that they do not
face the uncommon occurrence of having to give up a large amount of income since this deal increases
their expected utility. An insurance company will always try to take in more in premiums paid than claims
paid out to claimants so that their owners receive at minimum a normal profit.
4. What kinds of risks can’t be insured?
Insurance works because the risks of adverse outcomes are independent, that is, one person suffering a loss
does not affect the likelihood that other people will suffer similar losses. If the losses from an event are not
independent, so that “everyone” suffers a loss at the same time, then the risk of loss cannot be insured.
Page 484
1. How does private information create adverse selection and moral hazard?
Both moral hazard and adverse selection are the result of private information. Moral hazard occurs when,
after an agreement has been reached, one of the parties to the agreement has the incentive to gain
additional benefits at the expense of the other party. Adverse selection refers to people who accept certain
contracts and have private information that allows them to benefit from the contract while harming the
other party. Both moral hazard and adverse selection can affect negatively the way in which markets
function.
2. How do markets for cars use warranties to cope with private information?
Warranties serve to limit the adverse selection and moral hazard problems in the market for cars.
Essentially, warranties (and guarantees in general) are signals provided to potential buyers that the product
under consideration has been examined by experts and is a high-quality item. Without the existence of
these signals, the lemon problem, whereby only low-quality products are offered for sale, may occur
because buyers realize that all sellers claim that they are selling high-quality goods but that adverse selection
implies that the goods sold are of low quality.
3. How do markets for loans use signaling and screening to cope with private information?
Lenders in the loans market want to separate high-risk borrowers from low-risk borrowers so that they can
charge high-risk borrowers a high interest rate and low-risk borrowers a low interest rate. They use signals
and screens to help them do so. They screen borrowers by asking for information that helps them assess
the riskiness of the loan and the borrower. If the borrower does not reveal the information requested, the
lender has screened the borrower into the high-risk category. The information requested will provide
signals about the borrower’s riskiness. For instance, if a borrower has defaulted on debt in the past this fact
signals that the borrower is a high-risk individual.
4. How do markets for insurance use no-claim bonuses to cope with private information?
“No-claim” bonuses are commonly used in auto insurance. One of the most important pieces of
information a person can give an auto insurance company is his or her propensity to drive safely and avoid
accidents. However, this information is only believable to the extent that driving records really do
© 2023 Pearson Education, Inc.
by Michael Parkin
Complete Chapter Solutions Manual
are included (Ch 1 to 20)
** Immediate Download
** Swift Response
** All Chapters included
** Solutions Sheets
,Table of Contents are given below
Chapter 1 What is Economics?
Chapter 2 The Economic Problem
Chapter 3 Demand and Supply
Chapter 4 Elasticity
Chapter 5 Efficiency and Equity
Chapter 6 Government Actions in Markets
Chapter 7 Global Markets in Action
Chapter 8 Utility and Demand
Chapter 9 Possibilities, Preferences, and Choices
Chapter 10 Organizing Production
Chapter 11 Output and Costs
Chapter 12 Perfect Competition
Chapter 13 Monopoly
Chapter 14 Monopolistic Competition
Chapter 15 Oligopoly
Chapter 16 Public Choices, Public Goods, and Healthcare
Chapter 17 Externalities
Chapter 18 Markets for Factors of Production
Chapter 19 Economic Inequality
Chapter 20 Uncertainty and Information
,Solutions Manual organized in reverse order, with the last chapter
displayed first, to ensure that all chapters are included in this document.
(Complete Chapters included Ch20-1)
C h a p t e r 20 UNCERTAINTY
AND INFORMATION
Answers to the Review Quizzes
Page 476
1. What is the distinction between expected wealth and expected utility?
Expected wealth is the money value of what a person expects to own at a point in time. Expected utility is
the utility value of what a person expects to own at a point in time. These concepts both measure the value
of what a person expects to own at a point in time but they differ because expected wealth is the money
value and expected utility is the utility value.
2. How does the concept of utility of wealth capture the idea that pain of loss exceeds the
pleasure of gain?
The utility of wealth has diminishing marginal utility. Diminishing marginal utility means that the
decrease in utility from a dollar decrease in wealth, that is, the pain of loss, is greater than the increase in
utility from a dollar increase in wealth, that is, the pleasure of gain.
3. What do people try to achieve when they make a decision under uncertainty?
When making decisions under uncertainty people maximize their expected utility.
4. How is the cost of risk calculated when making a decision with an uncertain outcome?
A decision made with uncertainty has an expected wealth and an expected utility that depend on the
probability, wealth, and utility associated with the different outcomes. Because people are risk averse, the
amount of certain wealth that creates the utility equal to the expected utility in the uncertain case is less
than the expected wealth in the uncertain case. The difference between the expected wealth in the
uncertain case and the certain wealth that creates the same level of utility is the cost of risk.
Page 479
1. How does insurance reduce risk?
Insurance reduces the risk any individual faces because insurance pools risks. Everyone pays into the pool
but only the small fraction of people who suffer a loss are paid from the pool. Essentially people reduce the
risk of a large adverse financial outcome in exchange for the small, certain payment to the insurance
company.
2. How do we determine the value (willingness to pay) for insurance?
The amount that someone would be willing to pay to avoid risk is measured using the person’s utility of
wealth schedule or curve. The important feature of the curve is that the marginal utility of wealth
diminishes as wealth increases. The rate at which the marginal utility of wealth declines determines the
degree of the individual’s risk aversion, that is, how much he or she is willing to pay to avoid risk.
Suppose a person faces the risky situation of receiving wealth of W1 (with utility of U 1 ) or a smaller
amount, W2 (with utility of U 2 ). The expected wealth from this situation is EW, and the expected utility
is EU. This risky situation has the same utility as receiving some amount of certain wealth, W. The
difference in wealth between the risky high level of wealth and the sure case, W1 – W, measures the value
© 2023 Pearson Education, Inc.
, 276 CHAPTER 20
of insurance in this situation to this individual. The more rapidly the marginal utility of wealth declines,
the more risk averse is the person because the more wealth the individual is willing to give up to guarantee
a certain (albeit lower) amount of wealth. That is, the more concave the utility of wealth curve, the less is
the certain wealth that has the same utility as the expected utility from an uncertain, risky outcome.
3. How can an insurance company offer people a deal worth taking? Why do both the buyers and
the sellers of insurance gain?
Insurance companies work by pooling risks so that everyone pays into the pool but only the (small)
fraction of people who suffer a loss are paid from the pool. Although the likelihood of a bad occurrence is
small for each individual, for a large enough group the total number and total amount of losses can be
estimated very closely. The insurance company can calculate the size of the pool required to cover losses.
From this calculation the company can compute the amount of the premium each person must pay into
the pool to cover all the anticipated losses and other costs the company incurs. People buy insurance
because they are risk averse; they want to avoid unwanted outcomes. Insurance is worth buying because
people are willing to give up a relatively small amount of income all the time to guarantee that they do not
face the uncommon occurrence of having to give up a large amount of income since this deal increases
their expected utility. An insurance company will always try to take in more in premiums paid than claims
paid out to claimants so that their owners receive at minimum a normal profit.
4. What kinds of risks can’t be insured?
Insurance works because the risks of adverse outcomes are independent, that is, one person suffering a loss
does not affect the likelihood that other people will suffer similar losses. If the losses from an event are not
independent, so that “everyone” suffers a loss at the same time, then the risk of loss cannot be insured.
Page 484
1. How does private information create adverse selection and moral hazard?
Both moral hazard and adverse selection are the result of private information. Moral hazard occurs when,
after an agreement has been reached, one of the parties to the agreement has the incentive to gain
additional benefits at the expense of the other party. Adverse selection refers to people who accept certain
contracts and have private information that allows them to benefit from the contract while harming the
other party. Both moral hazard and adverse selection can affect negatively the way in which markets
function.
2. How do markets for cars use warranties to cope with private information?
Warranties serve to limit the adverse selection and moral hazard problems in the market for cars.
Essentially, warranties (and guarantees in general) are signals provided to potential buyers that the product
under consideration has been examined by experts and is a high-quality item. Without the existence of
these signals, the lemon problem, whereby only low-quality products are offered for sale, may occur
because buyers realize that all sellers claim that they are selling high-quality goods but that adverse selection
implies that the goods sold are of low quality.
3. How do markets for loans use signaling and screening to cope with private information?
Lenders in the loans market want to separate high-risk borrowers from low-risk borrowers so that they can
charge high-risk borrowers a high interest rate and low-risk borrowers a low interest rate. They use signals
and screens to help them do so. They screen borrowers by asking for information that helps them assess
the riskiness of the loan and the borrower. If the borrower does not reveal the information requested, the
lender has screened the borrower into the high-risk category. The information requested will provide
signals about the borrower’s riskiness. For instance, if a borrower has defaulted on debt in the past this fact
signals that the borrower is a high-risk individual.
4. How do markets for insurance use no-claim bonuses to cope with private information?
“No-claim” bonuses are commonly used in auto insurance. One of the most important pieces of
information a person can give an auto insurance company is his or her propensity to drive safely and avoid
accidents. However, this information is only believable to the extent that driving records really do
© 2023 Pearson Education, Inc.
