Question

TRUR/FALSE EXPLANATION

1.11 When an individual has utility function U(W) =W, the expected value and expected utility of a risky event are the same.

1.12 Risk averse individuals never prefer a lottery over a sure bet.

1.13 In a lemons market with adverse selection, the equilibrium always involves only the lemons being bought and sold.

1.14 If a firm achieves efficiency in production when hiring they also necessarily achieve efficiency in risk bearing.

1.15 Only the total compensation paid to a worker determines the amount of moral hazard they may engage in.

1.16 A fixed-fee rental contract always acheives production efficiency.

Answer 1

1.11. True. In this case, both E(W) = W and E (U(W)) = W.

1.12. False. Risk averse individual may prefer a lottery to a sure event if the expected value of the lottery exceeds the value of the sure event more than the cost of the risk.

1.13. True. In adverse selection, since there is no means to distinguish between lemons and peaches, and no one sells peaches at a lower price, only lemons are sold.

1.14. False. Production efficiency doesn't necessarily translate into efficiency in risk bearing.

1.15. False. Moral hazard is caused by problems in monitoring of the agents by the supervisor.

1.16. False. A fixed fee rental contract may lead to moral hazard and may be inefficient .