hw5 solution (chapter6)

# hw5 solution (chapter6) - Chapter 06 The Economics of...

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Chapter 06 - The Economics of Information and Choice Under Uncertainty Answers to Chapter 6 Problems 1. If the general threshold for denying admission is 80, and if those who deny admission are uniformly distributed between 80 and 100, then our best estimate of the messiness index of someone who denies admission will be 90. The threshold will not be stable. Someone whose messiness index is between 80 and 90 has good reason to let people in rather than be assumed to have an index of 90. A threshold of 90 should be unstable for similar reasons, as indeed will any disclosure threshold less than 100. In practice, the fact that some people do refuse to let others see their messy apartments seems to indicate that actually seeing the mess firsthand will be more damaging than having people conclude in the abstract that the apartment is messy. 2. One salient fact about teenage males is that they have much higher automobile accident rates than other groups. A company that charged the same rates to teenage males as it changes to all other groups would therefore have to have higher premiums than those other companies charge members of all other groups. There would then be no reason for these other group members to remain with the company. In the end, the company with uniform rates for all groups would have to charge a premium high enough to cover the expected losses of members in the highest risk group. 3. If all consumers value nondefective cars at \$6000 and used cars sell for only \$1000, then no nondefective cars will be offered for sale in the used market. The only used cars for sale will be defective, so we know that the value consumers place on a defective car must be exactly 1000. Since consumers are risk neutral, the expected value of a new car, E n , is simply the sum of the expected values of nondefective and defective cars: E n = (1-d)(6000) + d(1000) = 4000, which solves for d = 0.4.

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