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Unformatted text preview: Answers to Questions for Review 1. If anyone can fake the signal, it will cease to be a signal at all since it would be meaningless information. 2. The full disclosure principle means that advertisers will be eager to separate their products from products with lesser qualities. 3. Interviewees will have an incentive to tell information about which the employer may have concern even if the employer is not allowed to ask for the information. Employers may expect the worst, so the applicant will make sure that the employer knows that the worst is not true. 4. The low-risk types subsidize the high-risk people in the group, because the insurance company will charge a premium to cover the average claim. 5. The rate will be higher than it should be because those who are the best risks leave the pool and self- insure. That raises the rates for those left, and the best risks left are again inclined to self- insure. Thus the average premium keeps climbing. 6. It is logical that there are diminishing returns to wealth, and therefore risk aversion is normal. 7. Gambling and bungee jumping might help you start your list. 8. Focus on the idea that insurance companies will need to cover their risk and make profits. 9. The service contracts on small appliances and credit card insurance when the maximum loss is only $50 are two of the obvious ones. 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....
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This note was uploaded on 04/08/2008 for the course ECON 302 taught by Professor Toossi during the Spring '08 term at University of Illinois at Urbana–Champaign.
- Spring '08