4/26/2020 Quiz 11: Information Economics: Price Theory (2020)

Quiz 11: Information Economics

Due 10 Apr at 23:59 Points 10 Questions 4
Available 30 Mar at 0:00 - 10 Apr at 23:59 12 days Time limit 30 Minutes

Instructions
This is an individual assessment task. You must complete this task on your own.
Collaboration, or any other form of assistance not explicitly authorise by the University, is not
permitted.

1. You have 30 minutes to complete this quiz.

2. You have one (1) attempt.
3. There are ten (10) marks available in this quiz.

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This quiz was locked 10 Apr at 23:59.

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Attempt history

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Attempt
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LATEST Attempt 1 17 minutes 9 out of 10
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Score for this quiz: 9 out of 10

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Submitted 6 Apr at 19:16

This attempt took 17 minutes.
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Question 1 4 / 5 pts
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Insuragard sells insurance policies that completely compensate

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drivers in the event of an accident. The cost of compensating a

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driver is $10,000, while the risk of an accident varies from driver to

driver. Suppose that there are four drivers in the market for car
insurance:
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Doug has a 0% chance of having a car accident, and is willing

to pay $0 for an insurance policy.
Sarah has a 5% chance of having a car accident, and is willing
to pay $600 for an insurance policy.
Graham has a 10% chance of having a car accident, and is
willing to pay $1200 for an insurance policy.
Audrey has a 15% chance of having a car accident, and is
willing
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4/26/2020 Quiz 11: Information Economics: Price Theory (2020)

Each driver knows her/his own risk of having an accident, because

each driver knows how carefully she/he drives. However, this
information is hidden from Insuragard (Insuragard does know the
distribution of risk in the market).

Hint: Before proceeding, calculate the expected payout to each

individual.

Use the information provided to answer the following questions:

i. If Doug, Sarah, Graham and Audrey all purchase a policy, the

fair price is $750 .
ii. If Sarah, Graham and Audrey all purchase a policy, the fair

price is [ Select ] .

iii. If Graham and Audrey both purchase a policy, the fair price is

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[ Select ]

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iv. If only Audrey purchases a policy, the fair price is

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[ Select ] rs e .
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v. If Insuragard will not sell policies for less than the fair price, the
maximum number of drivers who can be covered by a policy is
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[ Select ] .
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Answer 1:
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Correct! $750
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Answer 2:
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Correct! $1000
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Answer 3:

Correct! $1250
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Answer 4:

Correct! $1500

Answer 5:

orrect answer 1

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4/26/2020 Quiz 11: Information Economics: Price Theory (2020)

The expected payouts to the four drivers are:

Doug:
Sarah:
Graham:
Audrey:

Using these values we can answer the five questions.

1. The fair price is the average of the expected payouts.
Therefore, if Doug, Sarah, Graham and Audrey all purchase
policies, the fair price is
.
2. If Sarah, Graham and Audrey all purchase policies, the fair
price is .

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3. If Graham and Audrey both purchase policies, the fair price

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4. If Audrey alone purchases a policy, the fair price is $1500.

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5. The only case in which the fair price is less than the
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willingness-to-pay of all drivers who purchase a policy is
when Audrey alone purchases a policy.
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Question 2 1 / 1 pts
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Identify the truthfulness of the following statements:

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i. If health insurance companies know the likelihood that each

individual in the market will require medical attention, and the
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law states that all individuals must be charged the same price
for a policy, then market unravelling is not possible.
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ii. Universal health care ensures that all citizens are insured
against the cost of medical treatment, regardless of each
citizen's willingness-to-pay for an insurance policy.

Both i and ii are true.

Both i and ii are false.

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true; ii is false.
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4/26/2020 Quiz 11: Information Economics: Price Theory (2020)

Correct! i is false; ii is true.

Market unravelling can occur when an insurance company has

information about each individual's risk, so long as the
company is not permitted to use that information.

Under universal health care, citizens are either provided with

health care at no cost, or required to purchase a policy. In either
case, a citizen's willingness-to-pay is not considered.

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Question 3 1 / 1 pts

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The salaries available to university graduates are typically higher than the

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salaries available to workers without a degree. According to the signalling theory
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of education, a university degree is an effective signal of high ability if the cost
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(disutility) of acquiring a degree is less than benefit (utility gain) from a graduate
salary for
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both high and low ability individuals.

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neither high nor low ability individuals.

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Correct!
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high ability individuals, but not for low ability individuals.

low ability individuals, but not for high ability individuals.

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To be an effective signal, it must be worthwhile for high ability

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individuals to get an education, but not for low ability individuals.

Question 4 3 / 3 pts

A cosmetics company hires an advertising executive to produce a

campaign
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 4/26/2020 Quiz 11: Information Economics: Price Theory (2020)

if the executive exerts high effort, and if

he exerts low effort. The cosmetics company cannot observe the
advertising executive's effort.

The executive's utility is described by the function ,

where if the executive exerts low effort, and if he
exerts high effort. If the executive does not work for the cosmetics
company, he will receive 290 units of utility from other endeavours.

The cosmetics company offers the executive a contract that pays

if sales of the new mascara are good, and
if sales are bad. This contract satisfies the
participation constraint, and does not satisfy the incentive
compatibility constraint.

Answer 1:

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Correct! satisfies

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Answer 2:

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Correct! does not satisfy
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The participation constraint requires

. Given that
and , the lefthand side of the
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participation constraint is (approximately) equal to 316 which is

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greater than 290.

The incentive compatibility constraint requires

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. The lefthand side of this equation is (approximately) equal to

316, this is less than the righthand side which is (approximately)
equal to 326.
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Quiz score: 9 out of 10

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