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BUS 312 Midterm Exercises

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30 views14 pages

BUS 312 Midterm Exercises

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fungilism
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Question 1: Irem has a utility function U(x)= x 1/3.

She is indifferent between 1000 TL for sure and a


lottery which offers m TL with probability ½ and zero with probability ½. She does not need to make
a payment to get the lottery.

a) Determine m.

b) Is Irem risk loving, risk neutral or risk averse?Discuss briefly the concepts of Certainty
Equivalent (CE) and Expected Monetary Value of the Lottery (EMV) and justify your
result based on these concepts of CE and EMV.

Question 2: How does a risk loving decision decission maker with U(x) = x 2 rank the options
below from the most prefereed to the least

(1)A sure payment 6

(2) A gamble with prizes 0TL, 10TL with probabilities 0,5 and 0,5

(3) A gamble with prizes 3TL, 5 TL and 8 TL with probabilites 0.4, 0.2 and 0.4.

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BUS 312: MANAGERIAL ECONOMICS

Question 3:Doruk studies in Paris and uses a bike to get around. If his bike is stolen he would have to
replace it which would cost him 300 EURO. He finds out that 20 % of the bikes in Paris are stolen
every year. His total wealth is 400 EURO for a year. His utility of money function is given by U(x) =
x ½.

a) Suppose that Doruk considers to take out insurance with full coverage for a year. What is
the maximum premium that he would accept to pay for buying that insurance?

b) Discuss briefly what does “Fair Premium” mean. Calculate the fair premium that the
insurance company would ask Doruk.
c) Suppose that the insurance company payspays him 108 EURO and asks as the Premium 39
Euro. Does Doruk accept this partial coverage insurance? What will be the lowest
payment so that Doruk will accept paying 39 Euro for that partial coverage?

d) Calculate the fair premium that the insurance company would ask Doruk if it gives a
partial coverage in the amount of 108 EURO .

Question 4: Consider a population of individuals each having an initial wealth of W and facing a
potential loss of L. A fraction α is low risk and incurs the loss with probability p L and a fraction ¿) is
high risk and incurs the loss with probability p H . Everyone has to buy insurance. The insurance premia
are actuarially fair.

Let U(x) = ln x, W = 1000, L= 600, α =0.4; p L=0.1 and p H = 0.2. Suppose that the high risk person are
ready to pay at most 150 and low risk person are ready to pay at most 75.

a. Suppose that there is no hidden information, there are two full insurance policies with
fair premium designed for both types. What will be the fair premiums Rl and Rh?
Who will buy the policies?

b. Suppose the insurance company does not know who is low type and who is high type.
The company does only know the fraction. Suppose the only insurance policy
available is full insurance for everybody.
What is the premium? Who will buy the policy?

c. Suppose that in addition to full insurance, a deductible policy is available whereby the
insurance company pays out 100 in case of loss. Write down the condition so that the
high risk types buy full insurance, but not the one with dedeuctibles.
1
Question 6: Let the agent’s utility U ( w ,e )=w 2 – e . The principal is risk neutral. The agent can
decide to shirk (kaytarma) or not, shirking corresponds to e=0 , and not shirking corresponds to e=4.
The agent generates a revenue of $ 0 and $ 12000, with probabilities given in the table below:

Revenue for principal is 0 Revenue for principal is 12000

e=0 (shirk) 1/2 1/2

e=5 (work) 1/4 3/4

The agent’s reservation utility is u=6, that is the utility he will get from an alternative job.

a. If the principal can observe the effort what is the optimal wage she is willing to offer?
b. Assume that the principal cannot observe the effort and the following payment scheme
applies: The principal pays the agent x if the revenue to the principal is $0 and pay
him y if the revenue to the principal is $ 12000. (Note that x,y ≥0.) What is the
optimal wage the principal is willing to offer to the worker?
c. What is the revenue of the principal?

Question 7: A risk neutral firm decides whether to build a new factory or not. If he does not build a
factory there will be no loss or profit. If he decides to build the factory: With the probability of 0.2 the
demand will be low and in that case, there will be a loss, in other words, a negative profit of -
$100.000. With the probability of 0.8 the demand will be high and in that case, there will be a profit
of $200.000.

The company tries to gain extra information and for that reason asks to a consultant agency whether
the demand will be high or low. We assume that the consultant agency knows the demand accurately.
After getting this information, the firm makes its decision.

What will be the maximum amount of payment (EVPI) that the firm is willing to pay to the
consultancy agency for this information?

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