20-1 Extended Warranties

Your product fails about 2% of the time, on average. Some customers purchase the extended warranty you offer in which you will replace the product if it fails. Would you want to price the extended warranty at 2% of the product price? Discuss both moral hazard and adverse selection issues.

20-3 Locator Beacons for Lost Hikers

Lightweight personal locator beacons are now available to hikers that make it easier for the Forest Service's rescue teams to locate those lost or in trouble in the wilderness. How will this affect the costs that the Forest Service incurs?

20-4 Auto Insurance

Suppose that every driver faces a 1% probability of an automobile accident every year. An accident will, on average, cost each driver $10,000. Suppose there are two types of individuals:those with $60,000 in the bank and those with $5,000 in the bank. Assume that individuals with $5,000 in the bank declare bankruptcy if they get in an accident. In bankruptcy, creditors receive only what individuals have in the bank. What is the actuarially fair price of insurance? What price are individuals with $5,000 in the bank willing to pay for the insurance? Will those with $5,000 in the bank voluntarily purchase insurance? What is the effect of state laws forcing individuals to purchase auto liability insurance?

19-1 Leasing Residuals

In the late 1990s, car leasing was very popular in the United States.A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car.If the customer decided to keep the car, the customer would pay a price to the manufacturer, the "residual value," computed as 60% of the new car price.The manufacturer would then sell the returned cars at auction.In 1999, the manufacturer lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value).

Why was the manufacturer losing money on this program?

What should the manufacturer do to stop losing money (while still leasing cars)?

Please remember to explain your answers - tell me why?