56 terms

Suppose a risk-neutral competitive firm must set output before it knows for sure the market price. Suppose the market price is given by p = p** + e, where p** is the mean price and e is a random term with an expected value of zero. Then in order to maximize expected profits, the

firm should produce where:

firm should produce where:

p* = MC.

Suppose a risk-neutral competitive firm must produce output before the market price is known. If the uncertain price is given by p = p* + e, where e is a random term with an expected value of

zero, a competitive firm should shut down in the short run if:

zero, a competitive firm should shut down in the short run if:

p* < AVC

In the presence of ______, the market mechanism can break down.

asymmetric information

_______ occurs when people smoke more after buying life insurance

Moral hazard

To maximize profit in the face of uncertainty, firms should produce the output where:

expected marginal revenue equals marginal cost

Joe's search costs are $5 per search. He wants to buy a video player for his wife for Christmas, and the lowest price he's found so far is $300. Joe thinks 80 percent of the stores charge $300 for video players and 20 percent charge $200. Joe's optimal decision is to:

continue to search for a lower price since the expected benefit of an additional search is $20, which exceeds his per-unit search costs

Joe's search costs are $5 per search. He wants to buy a video player for his wife for Christmas, and the lowest price he's found so far is $200. Joe thinks 50 percent of the stores charge $200 for video players and 50 percent charge $190. Based on this information

Joe is indifferent between searching again and stopping.

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. Which project has the greatest expected value?

corresponding payoffs are summarized in the following table. Which project has the greatest expected value?

$50/$50

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. Which project has the lowest expected value?

corresponding payoffs are summarized in the following table. Which project has the lowest expected value?

$30/-$30

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. Which project has the greatest variance?

corresponding payoffs are summarized in the following table. Which project has the greatest variance?

$30/-$30

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. Which project has the lowest variance?

corresponding payoffs are summarized in the following table. Which project has the lowest variance?

$50/$50

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. A risk-neutral manager will prefer project:

corresponding payoffs are summarized in the following table. A risk-neutral manager will prefer project:

$50/$50

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. A risk-averse manager will prefer project:

corresponding payoffs are summarized in the following table. A risk-averse manager will prefer project:

$50/$50

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. A risk-loving manager will prefer project:

corresponding payoffs are summarized in the following table. A risk-loving manager will prefer project:

$50/$50

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. Which project yields the greatest return, regardless of whether a boom or a recession occurs?

corresponding payoffs are summarized in the following table. Which project yields the greatest return, regardless of whether a boom or a recession occurs?

$50/$50

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. The expected value of project A is:

corresponding payoffs are summarized in the following table. The expected value of project A is:

$5

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. The expected value of project B is:

corresponding payoffs are summarized in the following table. The expected value of project B is:

$5

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. The expected value of project C is:

corresponding payoffs are summarized in the following table. The expected value of project C is:

None of the answers are correct.

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. The expected value of project D is:

corresponding payoffs are summarized in the following table. The expected value of project D is:

None of the answers are correct.

You are a hotel manager and you are considering four projects that yield different payoffs, depending upon whether there is an economic boom or a recession. The potential payoffs and

corresponding payoffs are summarized in the following table. If a manager adopted both project A and B simultaneously, the expected value of this joint

project would be:

corresponding payoffs are summarized in the following table. If a manager adopted both project A and B simultaneously, the expected value of this joint

project would be:

10

A fair coin is flipped. You will be paid $1 when it is heads and penalized $1 otherwise. What is the variance of the payoffs?

1

Suppose option A has a higher variance than option B. Which of the following statements is, in general, true?

There is insufficient information to determine which is true.

Tim is offered two gambles. With gamble A, he either gains $2 or loses $1 with a 50 percent probability. With gamble B, he either gains $3 or loses $2 with a 50 percent probability. Tim prefers gamble B to gamble A. What can we conclude?

Tim is risk loving

Risk-averse persons sometimes prefer to play some gambles even if they know that those gambles are not fair, i.e., on average people lose by playing them. One plausible explanation for this seemingly paradoxical phenomenon is that

Gambling has entertaining effects which are not treated explicitly as part of the payoffs.

Which of the following phenomena shows that risk aversion is the characteristic of many people?

Auto insurance

Jane wants to buy a beautiful doll as a gift for her sister's birthday. She knows that the same product is offered in different shops with prices of $120, $100, and $80 with odds of one-third of finding each price. She just stopped at a shop and knows that the price is $100. Suppose that

there is a search cost of $5 for each search. Should she search one more time?

there is a search cost of $5 for each search. Should she search one more time?

Yes

Jane wants to buy a beautiful doll as a gift for her sister's birthday. She knows that the same product is offered in different shops with prices of $120, $100, and $80 with odds of one-third of finding each price. She just stopped at a shop and knows that the price is $100. If the search

cost is $8 per time, what should she do?

cost is $8 per time, what should she do?

Accept the offer in hand.

An incumbent usually charges a higher price than a new entrant does. Which of the following is a plausible reason for this observation?

Consumers are risk averse, hence new firms charge lower prices to attract customers.

An apple farmer must decide how many apples to harvest for the world apple market. He knows that there is a one-third probability that the world price will be $1, a one-third probability that it will be $1.50, and a one-third probability that it will be $2. His cost function is C(Q) =

.01Q2. If the farmer is risk neutral:

.01Q2. If the farmer is risk neutral:

he strictly prefers to produce.

Which of the following is a possible critique of the decision theory under uncertainty presented in the text?

People do not always know the "true" probability of complicated events.

Which of the following statements is NOT correct?

A. Information plays an important role in the economy.

B. Asymmetric information may lead to the disappearance of a market. C. It is always desirable to have more information than the person one is trading with. D. Adverse selection will not occur if there is no asymmetric information.

A. Information plays an important role in the economy.

B. Asymmetric information may lead to the disappearance of a market. C. It is always desirable to have more information than the person one is trading with. D. Adverse selection will not occur if there is no asymmetric information.

It is always desirable to have more information than the person one is trading with.

After a person buys insurance for his car, he will generally not care for his car as much as he otherwise would. This is an example of:

moral hazard.

People with a bad driving record find it difficult to buy automobile insurance because insurance companies fear that ___________ may happen if they raise the premiums

adverse selection

Suppose that there are two types of cars, good and bad. The qualities of cars are not observable but are known to the sellers. Risk-neutral buyers and sellers have their own valuation of these two types of cars as follows: Suppose that both buyers and sellers observe the quality. What happens?

Both good and bad cars are traded.

Which of the following is a means of eliminating the undesirable effects of adverse selection?

Both a long-term relationship and writing a contract to guarantee the quality

Which of the following types of auctions was NOT described in the text?

Third-price sealed bid auction

Which of the following statements is NOT true?

A. The Dutch and first-price, sealed-bid auctions are strategically equivalent.

B. A mineral rights auction is a common value auction. C. An auctioneer is always indifferent between different kinds of auctions. D. An English auction yields higher expected revenues than a second-price, sealed-bid auction

when bidders are risk averse.

A. The Dutch and first-price, sealed-bid auctions are strategically equivalent.

B. A mineral rights auction is a common value auction. C. An auctioneer is always indifferent between different kinds of auctions. D. An English auction yields higher expected revenues than a second-price, sealed-bid auction

when bidders are risk averse.

An auctioneer is always indifferent between different kinds of auctions.

Which of the following is a feature of a Dutch auction?

The auctioneer begins with a very high asking price.

When each bidder in an auction knows what the item is worth to that bidder, but does not know the valuations of other bidders, the auction exhibits:

private values.

The optimal bid in a first-price, sealed-bid auction with independent private values is to bid:

less than the true value of the item.

Which of the following auction examples has a common value information structure?

Three firms bid for an oil lease.

The winner's curse occurs:

in a common-values auction.

To avoid the winner's curse, a bidder should:

revise downward his private estimate of the value of the item.

John is a seller in an affiliated-values auction environment where bidders are risk neutral. Which auction yields John the greatest expected revenue?

English

John is a seller in an independent private-values auction environment where bidders are risk neutral. Which auction yields John the greatest expected revenue?

All of the choices are revenue equivalent.

The optimal strategy for a risk-neutral bidder in a second-price, sealed-bid auction with independent private values is to bid:

his or her true valuation.

A consumer spends more time searching for a good when her reservation price is:

reduced.

If insurance companies are required to offer coverage to all interested people, it is said that premiums for each person will be increased. Assume that the insurance market is perfectly competitive. What is the major reason for raising the premium?

Less healthy people join the pool of insured and hence increase the risk and the premium.

Holding the mean constant, the larger the standard deviation, the ____________ the gamble will be

more risky

Suppose option A has a higher expected value than option B. Which of the following

statements is, in general, true?

statements is, in general, true?

A risk-averse person prefers option B to option A.

Suppose option A has a lower expected value than option B. Which of the following statements is, in general, true?

A risk-averse person prefers option B to option A.

Which of the following is NOT an example of a managerial decision with risk-averse

consumers?

consumers?

All of the statements associated with this question illustrate examples of managerial

decisions with risk-averse consumers.

decisions with risk-averse consumers.

Consider a game that pays 2n cents if the first tail is on the nth toss of a fair-headed coin. Determine the expected value of this game.

Infinite cents

The St. Petersburg paradox occurs when:

individuals are willing to pay significantly less than the expected value of a gamble.

Consider a market for product X where 75 percent of the stores charge $500 and 25 percent charge $450. Compute the expected benefit from an additional search when the first search results in a price of $500.

$12.50

The optimal bid in a first-price, sealed-bid auction with independent private values is to bid:

less than the true value of the item.