432sample 2 - D r Westerhold Econ 432 Sample 2 Review...

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Dr. Westerhold Econ 432 Sample 2: Review questions on insurance, health care and moral hazard: 1. Suppose there are two drivers, Jermaine and Janet. Jermaine is not a very safe driver. In fact, there is a 7.5% chance that he will have an accident within the next year. Janet is a relatively safe driver. Her chances of having an accident in the next year are only 1%. If Jermaine is involved in an accident, he will cost the insurance company $1,000,000. If Janet is involved in an accident, she will only cost the company $500,000. What is the expected pay-out that the company can expect from insuring these two? 2. Suppose your city government is interested in reducing littering. Currently, there is a $100 fine for littering and a 10% probability of being caught if you litter. A. Determine the current expected cost associated with littering. Show your work.
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The city is deciding between two different policies to reduce littering: Option 1: Increase the number of police that monitor littering increasing the probability of getting caught to 20% OR Option 2: Keep the monitoring level the same but raising the fine for littering from $100 to $200.
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B. Calculate the expected cost to a citizen of littering under Option 1 vs. Option 2?
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