Chapter 12: risk and auctions

Which project has the lowest expected value?

Project C; Expected Values: A = 0.5(20 -10) = 5 B = 0.5(-10 + 20) = 5 C = 0.5(30 - 30) = 0 D = 0.5(50 + 50) = 50

Which project has the highest variance?

Project C; Variance = Sum(x-M)^2/N so, M= 50-50/2 = 0 Variance= {(50-0)^2+(-50-0)^2}/2 =2500

If a manager adopted both project A and project B simultaneously, the expected value of this joint project would be:

20; 0.5*(40-10)+0.5*(-20+30) = 20

A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent chance the firm's demand curve will be P = 40 − Q and a 50 percent chance it will be P = 60 − Q. The marginal cost of the firm is MC = 3Q. The expected profit-maximizing price is:

$40; E[MR]=MC MC=3Q P= .5(40-Q)+.5(60-Q)=50-Q MR=50-2Q set equal to 3Q Q=10 P=50-10= 40

Suppose you are a risk-neutral manager attempting to hire a new sales manager. All of the workers in the market have the same ability to manage and sell, but they differ with respect to the wage at which they are willing to work for your company. The market for sales managers is composed of two types of individuals: 35 percent are willing to work for $50,000 and 65 percent are willing to work for $75,000. The first interviewee is only willing to work for $75,000. The expected benefit from an additional search is:

$8,750; .35(75,000-50,000)= 8,750

The expected value of project B is:

B = 0.5(-10 + 20) = 5

A risk-neutral monopoly must set output before it knows the market price. There is a 50 percent chance the firm's demand curve will be P = 20 − Q and a 50 percent chance it will be P = 40 − Q. The marginal cost of the firm is MC = Q. The profits are maximized in the expected sense when:

E[MR]=MC; If managers are risk neutral, they will want to maximize expected profits where expected MR=MC

Consider a consumer who is searching for the lowest price for good X. The consumer knows that 75 percent of the time she will find a store charging $10 and 25 percent of the times she will find a store charging $7. The consumer will search again if her marginal cost of searching is constant and is:

Lower than or equal to .75; expected benefit equals .75 .25(10-3)=.75

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; Moral hazard is a situation in which one party engages in risky behavior or fails to act in good faith because it knows the other party bears the economic consequences of their behavior.

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. a. adverse selection b. moral hazard c. risk aversion d. none of the statements associated with this question are correct

a. Adverse selection; In economics, insurance, and risk management, adverse selection is a market situation where buyers and sellers have different information. The result is that participants with key information might participate selectively in trades at the expense of other parties who do not have the same information. (AKA. Only people with bad driving records will buy premium insurance)

Consider an antique auction where bidders have independent private values. There are two bidders, each of whom perceives that valuations are uniformly distributed between $100 and $1,000. One of the bidders is Sue, who knows her own valuation is $200. What is Sue's optimal bidding strategy in a first-price, sealed-bid auction? a. Submit a bid of $150. b. Submit a bid of $200. c. Submit a bid that is less than $150. d. Yell "mine" when the bid reaches $150.

a. Submit a bid of $150; in first-price sealed-bid auctions, the bidder will bid lower than her valuation of the good, so as to earn profit. b. in a second-price sealed-bid auction, english auction, and dutch auction c. N/A d. in english or dutch auction, not sealed-bids

Which of the following is a feature of a Dutch auction? a. The auctioneer begins with a very high asking price. b. The winner pays the second-highest bidder's valuation. c. Bidders write their valuation in a paper simultaneously and separately. d. More than one bidder will announce their valuation.

a. The auctioneer begins with a very high asking price 1. Descending sequential-bid auction 2. first bidder to raise hand at price wins (the longer you wait, the lower your chance of winning) b. describes a second-price, sealed-bid auction c. describes a sealed-bid auction d. describes an English Auction

Which of the following auction examples has a common value information structure? a. Three firms bid for an oil lease. b. An auction of a famous painting. c. A college in need of money decides to name a building on campus after the person willing to pay the most for the privilege. d. An auction of a famous painting and a college in need of money decides to name a building on campus after the person willing to pay the most for the privilege.

a. Three firms bid for an oil lease; value of oil lease is already determined by market b. value of famous painting is determined by individual private values (people who like art will pay more than people who don't) c. value determined by individual private values d. value determined by individual private values

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? a. 0. b. 1. c. 0.50. d. 0.25.

b. 1

_______ occurs when people smoke more after buying life insurance. a. Adverse selection b. Moral hazard c. Asymmetric information d. Cournot and Bertrand competition

b. Moral Hazard; Moral hazard is a situation in which one party engages in risky behavior or fails to act in good faith because it knows the other party bears the economic consequences of their behavior. a. Adverse selection results from asymmetric information. Individuals have hidden characteristics that affect the market. c. Asymmetric information occurs when one party has more information than another d. Not applicable

A consumer spends more time searching for a good when her reservation price is: a. increased. b. reduced. c. fixed. d. None of the statements is correct.

b. reduced; the lower a consumer's reservation price, the harder it is to find good at desired price, the more they have to search for a good within reservation 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: a. perfect information. b. common values. c. private values. d. partially private values.

c. Private values; Auction environment in which each bidder knows his own valuation of the item but does not know other bidders' valuations, and in which each bidder's valuation does not depend on other bidders' valuations of the object. a. when buyers and sellers know everything about all of the products within their market b. Auction environment in which the true value of the item is the same for all bidders, but this common value is unknown. Each bidder uses his or her own (private) information to form an estimate of the item's true common value d. N/A

Which of the following statements is true? a. A mineral rights auction is not the same as a common-value auction. b. An auctioneer is always indifferent between different kinds of auctions. c. The Dutch and first-price, sealed-bid auctions are strategically equivalent. d. An English auction always yields lower expected revenues than a second-price, sealed-bid auction

c. The Dutch and first-price, sealed-bid auctions are strategically equivalent. a. Mineral rights auction is a common-value auction b. auctioneer is not indifferent because different kinds of auctions can yield greater profits d. a second-price sealed-bid auction yields a lower price because it takes the second highest prices verses the first highest price.

Which of the following statements is true? a. A risk-neutral manager will prefer project D. b. A risk-averse manager will prefer project D. c. A risk-loving manager will prefer project D. d. All of the statements are correct.

d. All of the statements are correct; project D is in everyone's favor because project D has the highest payoff during a recession and during a boom.

Holding the mean value of a gamble constant, the larger the standard deviation, the:

more risky the gamble will be