Chapter 18/Uncertainty and Risk Aversion 1
Chapter 7: Practice Quiz
Uncertainty and Risk Aversion
1.Expected value is defined as
a.the profit on a fair bet.
b.the most likely outcome of a given experiment.
c.the outcome that will occur on average for a given experiment.
d.the relative frequency with which an event will occur.
2.If a fair game is played many times the monetary losses or gains will
a.be zero.
b.approach zero.
c.be negative.
d.be positive.
e.result in an outcome that cannot be determined without more information.
3.People who always choose not to participate in fair games are called
a.risk takers.
b.risk averse.
c.risk neutral.
d.broke.
4.Risk aversion is best explained by
a.timidness.
b.increasing marginal utility of income.
c.constant marginal utility of income.
d.decreasing marginal utility of income.
5.An individual will never buy complete insurance if
a.he or she is risk averse.
b.insurance premiums are unfair.
c.he or she is a risk taker.
d.insurance premiums are fair.
6.Risk-averse individuals will diversify their investments because this will
a.increase their expected returns.
b.provide them with some much-needed variety.
c.reduce the variability of their returns.
d.reduce their transactions costs.
e.reduce their expected returns.
7.A risk-averse individual is offered a gamble that promises a gain of $1000 with probability 0.25 and a loss of $300 with probability 0.75. Given this situation, he or she will
a.definitely take the gamble.
b.definitely not take the gamble.
c.definitely take the gamble if his or her income is high enough.
d.take an action that cannot be determined given the information available.
8.Suppose a person’s utility of wealth is given by
and his or her initial wealth is $10,000. What is the maximum amount he or she would pay for insurance against a 50 percent chance of losing $3,600?
a.$1,800.
b.$1,900.
c.$2,000.
d.$2,100.
9.Which of the following utility functions exhibits constant absolute risk aversion?
a.U(W) = W.
b.
c.U(W) = ln W.
d.U(W) = .
10.Which of the following utility functions exhibits constant relative risk aversion?
a.U(W)= W.
b.
c.U(W)= lnW.
d.U(W)= .
11.Which of the following utility functions would indicate the most (relative) risk-averse behavior?
a.U(W) = W.
b.U(W) = .
c.U(W) = lnW.
d.U(W) = –1/W.
12.An individual whose utility function is given by
(where Wi is wealth in state i) will
a.never gamble no matter how favorable the odds.
b.only gamble if the expected value of the bet is positive.
c.gamble if the bet is not too unfair.
d.always gamble, no matter how unfavorable the odds.
13.For a person whose utility of wealth is given by U=W0.5 facing wealth of 100 with probability 0.5 and wealth of 400 with probability 0.5, the certainty equivalent of wealth
a.is 200.
b.is 225.
c.is 250.
d.is 300.
e.cannot be determined from the information given.
14.A risk averse person who has expected wealth of 100,000 but faces some risk of a loss will have
a.higher utility as the size of the loss increases.
b.lower utility as the size of the loss increases.
c.higher expected utility as the size of the loss increases.
d.lower expected utility as the size of the loss increases.
e.higher expected utility as the size of the gain increases.
15.A risk averse person whose utility exhibits constant risk aversion has the opportunity to make a bet that has a positive expected value. Which of the following is true about her willingness to take this bet?
a.If she would take the bet when her wealth is 10,000 then she would be willing to take the bet when her wealth is 100,000.
b.If she would take the bet when her wealth is 10,000 then she would be willing to take the bet when her wealth is 1,000.
c.If she would take the bet when her wealth is 10,000, then she wouldn’t be willing to take the bet when her wealth is 1,000.
d.Both a and b are true.
e.Both a and c are true.
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Chapter 20/Externalities and Public Goods 1
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