1. In the market for insurance, the moral-hazard problem is that ________encourages ________.
2. While shopping for office equipment, an office manager sees a display of fire extinguishers. After making a single phone call, the manager decides not to buy a fire extinguisher. The manager had called her ________and asked________?
3. Many professional athletes purchase insurance against career-ending injuries. We expect the insured players to experience ________ (more/fewer) injuries than uninsured players.
4. If the single firm providing bicycle theft insurance on campus disappears and is not replaced, we would expect bicycle theft rates on campus to ________.
5. Selling iPod Insurance. On the campus of Klepto College, half the iPods are expensive (replacement value is $400) and half are cheap (replacement value is $100). There is a 20 percent chance that any particular iPod expensive or cheap will be stolen in the next year. Suppose a firm offers iPod-theft insurance for $50 per year: The firm will replace any insured iPod that is stolen. Suppose the firm sells 20 insurance policies.
a. Assume for the moment that the theft rate remains at 20 percent for both types of iPods. The firm’s total revenue equals ________. The firms cost the money paid out to replace stolen iPods will be $________ to replace expensive iPods and $ ________to replace cheap iPods, for a total of $ ________. The insurance firm will make zero economic profit with a price of $ ________.
b. Is it realistic to assume that the introduction of insurance will not affect the theft rate? Which is a more plausible assumption, that the theft rate will decrease to 10 percent or that it will increase to 30 percent? For the more plausible theft rate, compute the zero-profit insurance price when insurance is purchased exclusively by the owners of expensive iPods.
6. Skydiver Question. Several of your friends have offered to take you on a tandem skydiving adventure: Strapped together with a single set of parachutes (main and emergency), you will all jump out of an airplane and then either float to earth or crash. All your skydiving friends are equally skillful, and none of them has the thrill-seeker gene. You can ask each of them a single question.
a. What s your question?
b. Provide the answer you re looking for in a skydiving mate.
7. Insurance and Fire Prevention. In a given year, there is a 10 percent chance that a fire in Ira s warehouse will cause $100,000 in property damage. If Ira spends $4,000 on a fire-prevention program, the probability of a fire would drop to zero.
a. If Ira doesn’t have fire insurance, will he spend the money on the prevention program?
b. If Ira has an insurance policy that covers 80 percent of the property damage from a fire (covering $80,000 of the $100,000 worth of damage), will he spend the money on the prevention program?