Problem Set 3 econ103 - Grade: A PDF

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Problem Set 3 econ103...

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Problem Set 3 Due Note that there are two types of problems. You are encouraged to work with someone else in your TA section on the quantitative problems (1, 2, 3); hand in one set of answers to these problems with both your names. You should do the essay question (4) individually and append separate answers with each person’s name for these to your group answers to the quantitative problems. Type your answers; hand-written answers will be accepted only by special arrangement. Staple pages together. Be sure to keep a copy of your answers in case of problem. Total 20 points.

1)

(7 points) Insurance and social policy

You are taking a job with a 70% chance of working for a year and earning $60,000 but a 30% chance of being unemployed after a few months and earning only $20,000. Your utility is the square root of income (Utility = Y.5). a)

(1 point) What is the expected value of your income from the job? What is your

utility at that income? 

$48,000 would be the expected income from your job, which I found using the equation (.7)(60,000)+(.3)(20,000). The utility income from your job would be $219.09 using the following formula: $48,000^.5.

Note that in EXCEL, the root function is “=X^.5” for the number X

b)

(1 point) What is your expected utility from your job? (Note: this is the weighted

average of utility when the app succeeds and when it fails where the weight is the probability of success.) 

$244.95 would be the expected utility from the job and I can show you using $60,000^.5=$244.95, this is when the app is successful. The expected utility of the failing app would be $141.42 using $20,000^.5=141.42. The expected utility from your job would then be $244.95 (.7) + 141.42 (.3)= $213.89.

c)

(1 point) What would be the price, P, of a risk-neutral insurance plan where you

have a guaranteed income of a successful job and the insurance company breaks even without make profit? What would your utility be at your income after paying break-even premiums? 

$18,000 would be the cost of the price, in which, a risk-neutral insurance plan guarantees income of a successful job and where the insurance company breaks even. This will be where the average payout of the insurance company insures the consumer. The reason is because a successful income of $60,000 that has a 70% chance of being recieved, have 30% times the $60,000 to ensure they are breaking even to find their price to insure which will be $18,000. If you behold a successful job the company guarantees the customer will get expected income, and the money paid to you matches sums of premiums, which would be $18,000. Where your utility will be at $228.04 from the equation (70,000-18,000)^.5.

(1 point) What is the maximum price you would be willing to pay? (Hint: what is

d)

the expected utility with and without insurance? The premium is the maximum amount that you would sacrifice to be guaranteed as much utility as without insurance.) 

I believe the maximum price I would be willing to pay for insurance would be $28,000 because at that value the utility will be the same without insurance valued at $219.09. Therefore, I would be willing to pay until it hit that point, which means every value under $28,000 has a higher expected utility then expected utility without the insurance.

e)

(1 point) Considering your answer to part A, in general, why do people buy

insurance? How can insurance companies profit? What happens to expected utility when people can buy insurance at a fair market price? 

The reason people buy insurance is because to are willing to pay now for the protection in the future. This is a term known as risk aversive. Insurance companies can profit from the wasteful investments or regulations. The two main terms used for insurance companies is “cherry picking” and “lemon dropping” which means they target healthy people who most likely won’t need the insurance. They also try to rid of sick clients, or clients who are not doing well. Therefore, they only want healthy clients because that will make them the most profit possible. Also, a insurance company can make profit off of return investments. When people can buy insurance at a fair market price the expected utility would increase, for the reason that, insurance protects them from uncertainty.

f)

(2 points) How else can insurance companies make profits? What is moral

hazard and what is adverse selection. How do these affect insurance markets? Give examples from the marketing of automobile insurance. Would you expect markets with moral hazard and adverse selection to provide the optimal amount of car insurance at an efficient price? 

Insurance companies have a variety of ways of making money. They can pick their own clients, which generates profit. While doing this they discourage other clients. They also offer broader policies. An example of this would be homeowners, disability, and bigger umbrella policies to cover more. Moral hazard lays off the risk and adverse selection chooses the healthy purchase their insurance policies. I believe that when you use these you are spreading the risk out, and have more of an opportunity to make profit. These insurance companies do not believe their safe drivers will get into accidents, so they give policies such as collision and liability to safe drivers. In terms of moral hazard and adverse selection, parents of teenagers who have just learned to drive will want car insurance because there is a higher likelihood of their kids crashing, but insurance companies will create higher rates for these kids because they have no evidence of safe driving.

2)

(5 points) Equilibrium discrimination and crowding. Suppose there are two

occupations, carpenters and anthropologists. a)

(2 points) Draw hypothetical supply and demand graphs for men and women to

both occupations assuming that some of each gender prefers each job. Now, assume

that discriminatory actions take place preventing men from becoming carpenters. Show the effects of discrimination on your graph. 

b)

(2 points) Who benefits and who loses from this discrimination? Show the effect

of discrimination on wages and employment in both occupations and on total output in each. (Hint: have one graph for carpenters, and a separate for anthropologists.) 

In the graph of the carpenters the men are the ones being discriminated against, which means that women in the carpentry industry will benefit from this discrimination. They would receive higher wages because of the less labor in the industry. This would lead to an increase in men in the anthropologist industry. In result, the wages would lower and the quantity of labor would increase. (both shown above)

c)

(1 point) Are there circumstances where the government should not prevent

discrimination? 

There should never be a circumstance where discrimination is ok. For example women get discriminated in various job opportunities, which drives the women into care industry and drives out the men.

3)

(4 points) Long-run competition. It would be very expensive to develop a

large lift vehicle to take people to Mars, and very expensive to develop a colony there, to establish water systems, farming, and oxygen production. Once these costs are paid, however, additional colonists could be sent to Mars relatively cheaply. a)

(1 points) You have been hired by Elon Musk to recommend pricing and marketing

strategies for his Mars plan. On one graph: Draw a hypothetical Average Total Cost

(ATC) curve, the Marginal Cost curve, and a Demand (MU) curve for sending people to Mars. (Hint: The point where Demand intersects MC should be below the ATC curve.) Sending People to Mars

b)

(1 point) Show the area of net profit (or loss) under perfect competition for Mars

settlement as the difference between average total cost and the average revenue (or the price). (Note that Musk’s profit (or the profit for SpaceX, his company) is the number of settlers times price minus ATC.) What will happen to the settlement if NASA starts a Mars colony? What will happen when a large number of new colonies are established? What happens to the industry and the number of companies under competitive conditions? Why? 

If there is an increase in colonies in mars the demand for the space ships will increase. Therefore, the curves will shift and the new equilibrium will be higher. This difference between the price and total cost will be at the profit level. If demand increases enough and surpasses cost the more profit will be produced. When more companies enter the industry competition will create a supply shift right decreasing the profit in the long run.

c)

(1 point) Duplicate the ATC, MC, & MU graph from part b, but this time, show

what happens if Musk can charge a monopoly price. Show the area of net profit as the difference between average total cost and the price multiplied by the number of settlers (Profit = (P – ATC)*Q). How does this change consumer, producer, and total surplus?



This changes consumer, producer, and total surplus because the producers gain more than the consumers. When there is less output, surplus is lost, and this changes the total surplus. This creates a decrease in consumer surplus.

d)

(1 point) Discuss at least three strategies Musk and SpaceX could follow to give it

more monopoly power and allow it to raise prices. 

The first strategy Musk and SpaceX could follow would be to create more discriminatory prices in order to increase demand which will also increase supply. This would allow them to raise the prices. Another strategy could be to create clear property rights to block the competitor. Lastly, Musk and SpaceX can combine with NASA to efficiently get to space.

4)

(4 points) Income insurance. Read Gerald Friedman, “Dog Walking and

College Teaching: The Rise of the Gig Economy” section 7.4 in Real World Micro a)

(2 points) What is the difference between traditional “jobs” and “gigs”? Why might

workers prefer one or the other? Why might employers? 

There are many differences between jobs and gigs, but the main one is that jobs are long-term connections to a certain business, while gigs are when people get a specific job/task with little connection to boss/employer. Workers who prefer a more flexible schedule would prefer a guig. The reason is because they can pick when they want a gig and then the employer will tell them what they have to do, while in a job you have set hours and set off days. If you prefer set hours, benefits, and the possible to climb up the ladder of the company you would

definitely prefer a job. On the other hand Employers may prefer one or the other depending on what is going on with the company. An employer might prefer a gig because they are paid lower wages, don’t get benefits, and easy to hire/fire, but they may prefer a job because the employee is more efficient when connected to the company. b)

(1 point) What has happened to the share of American workers with steady jobs

the 1970s? Who is responsible for the decline of “jobs”: does it reflect worker preferences or employer preferences? Why do you conclude this? 

The share of American workers with steady jobs the 1970s started to decrease because employers didn’t want to have to pay for benefits. Therefore, companies started to hire gigs for the reason of paying them less with no benefits. Employers were responsible for the decline in jobs. In their perspective they were scared of recession, so the easily hire/fire gigs, which led to a decrease in jobs. I conclude this because the workers do not have a say who gets the job. Therefore, employers made the decision of who gets the job and who doesn’t making them incontrol of the decrease of jobs.

c)

(1 point) Would it be desirable to provide workers with some other form of income

security? What might be done to make up for the decline in employer-provided income security? 

I believe that it would be desirable to provide workers with some sort of other form of income security. It may motivate workers and create an increase in efficiency. To make up for the decline in employer-provided income security the

government could tax the employers, employers could give more benefits. This will definitely motivate the worker and influence production....