Week 7 Managerial Economics Homework
17.1 Global Expansion: You’re the manager of global opportunities for a U.S. manufacturer, who is considering expanding sales in
Europe. Your market research has identified three potential market opportunities: England, France, and Germany. If you enter the
English market, you have 0.5 chance of big success (selling 100,000 units at a per-unit profit of $8), a 0.3 chance of moderate success
(selling 60,000 units at a per-unit profit of $6), and a 0.2 chance if failure (selling nothing). If you enter the French market, you have
a 0.4 chance if big success (selling 120,000 units at a per-unit profit of $9), a 0.4 chance of moderate success (selling 50,000 units at
a per-unit profit of $6), and a 0.2 chance failure (selling nothing). If you enter the German market, you have a 0.2 chance of huge
success (selling 150,000 units at a per-unit profit of $10, a 0.5 chance id moderate success (selling 70,000 units at a per-unit profit of
$6), and a 0.3 chance failure (selling nothing). If you can enter only one market, and the cost of entering the market (regardless of
which market you select) is $250,000, should you enter one of the European markets? If so, which one? If you enter, what is your
expected profit?
17.4 Hot Dog Uncertainty: You want to invest in a hot dog stand near the ballpark. You have a 03.5 probability that you can turn your
current $15,000 into $50,000 and a 0.65 probability that fierce competition will drive you to ruin, losing all your money. If you decide
not to enter, you keep your $15,000. Would you enter the market?
19.3 “Soft Selling” and Adverse Selection: Soft selling occurs when a buyer is skeptical of the quality or usefulness of a product or
service. For example, suppose you’re trying to sell a company a new accounting system that will reduce costs by 10%. Instead of
asking for a price, you offer to give them the product in exchange for 50% of their cost savings. Describe the information asymmetry,
the adverse selection problem, and why soft selling is a successful signal.
20-3 AIDS Insurance: Suppose your company is considering three health insurance policies. The first policy requires no tests and
covers all preexisting illnesses. The second policy requires that all covered employees test negative for the HIV virus. The third policy
does not cover HIV- or AIDS-related illnesses. All insurance policies are priced at their actuarially fair value. All individuals are
slightly risk averse. An individual with the HIV virus requires, on average, $100,000 worth of medical care each year. An individual
without the virus requires, on average, $500 worth of medical care each year.
a.
Suppose that the incidence of HIV in the population is 0.005. Calculate the annual premium of the first policy. (Hint: Adverse
selection.)
b.
If you don t have insurance that covers HIV-related illnesses, the probability of getting HIV is 1%. If you have insurance that
covers HIV-related illness, suppose that the probability of getting HIV is 2%. Calculate the premium of the second policy.
Show your calculations.(Hint: Moral hazard.)
c.
In Question 20-3b, suppose the insurance company wants to encourage low-risk behavior by individuals who have
insurance. On average, it “costs” individuals $100 to engage in low-risk behavior. Assume that if people get HIV, they pay
the deductible; and if they do not get HIV, they do not pay the deductible. How high much the deductible be to encourage
low-risk behavior?
d.
Calculate the premium of the third policy. Show your calculation.