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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 making a movie
with a 10% chance of making a ton-load of money, and 90% chance of
earning nothing. Your utility is the square root of income (Utility
= Y1/2); you will have $10,000,0001/2
happiness if your movie succeeds but 01/2 happiness if
it fails.

a) (1 point) What is the expected value of your movie? What is
your utility at that income? Note that in EXCEL, the square root
function is “=X^.5” for the number X b) (1 point) What is your
expected utility from your movie? (Note: this is the weighted
average of utility when the app succeeds and when it fails where
the weight is the probability of success.) c) (1 point) What would
be the price, P, of a risk-neutral insurance plan where you have a
guaranteed income of a successful movie and the insurance company
breaks even without make profit?

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

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?

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?

2) (5 points) Equilibrium discrimination and crowding. Suppose
there are two occupations, day-care teachers and plumbers.

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 prevent
men from becoming plumbers. Show the effects of discrimination on
your graph.

b) (1 point) 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 day-care teachers, and a separate one for
plumbers.)

c) (1 point) Wanting higher wages, day-care teachers
successfully lobby government to crack down on discrimination
practices. If discrimination is eliminated, show the changes that
will take place in the two labor markets. Who benefits and who
loses from the ban on discrimination?

d) (1 point) Are there circumstances where the government should
not prevent discrimination? Would you favor keeping
discrimination?

3) (4 points) Long-run competition. Most of the cost of a new
commercial jet is in the research and development and in building
production facilities. By contrast, the marginal cost of producing
another plane is relatively low.

a) (1 points) You have been hired by Boeing to recommend pricing
and marketing strategies for a new plane. On one graph: Draw a
hypothetical Average Total Cost (ATC) curve, the Marginal Cost
curve, and a Demand (MU) curve. (Hint: The point where Demand
intersects MC should be below the ATC curve.)

b) (1 point) Show the area of net profit (or loss) under perfect
competition for planes as the difference between average total cost
and the average revenue (or the price). (Note that Boeing’s profit
is the number of planes sold times price minus ATC.) What will
happen to the price of planes and sales and profits for Airbus when
its competitor, Boeing, comes out with a new plane? What happens to
the industry and the number of companies under competitive
conditions? Why?

c) (1 point) Duplicate the ATC, MC, & MU graph from part b,
but this time, show what happens if Boeing 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 cars
sold (Profit = (P – ATC)*Q). How does this change consumer,
producer, and total surplus?

d) (1 point) Discuss at least three strategies Boeing could
follow to give it more monopoly power and allow it to raise
prices.

4) (4 points) Health insurance. Read Gerald Friedman, “Universal
Health Care: Can we afford anything less?” at
http://www.commondreams.org/views/2011/07/01/universal-health-care-can-we-afford-anything-less

a) What has happened to the cost of health care in the United
States since the early 1970s? What has happened in other countries,
countries who do not have private health insurance?

b) Why would people expect private, for profit health insurance
companies to be more efficient than a government system? Why has
private health insurance led to higher costs?

c) Why has private health insurance led to worse health outcomes
for Americans?