w7 questions

attached:
  
1 . Individual Problems 18-1
You hold an oral, or English, auction among three bidders. You estimate that each bidder has a value of either $28 or $35 for the item, and you attach probabilities to each value of 50%. The winning bidder must pay a price equal to the second highest bid.
The following table lists the eight possible combinations for bidder values. Each combination is equally likely to occur.
On the following table, indicate the price paid by the winning bidder.
   
Bidder    1 Value

Bidder    2 Value

Bidder    3 Value

Probability

Price
 
($)

($)

($)
 
$28

$28

$28

0.125

 
$28

$28

$35

0.125

 
$28

$35

$28

0.125

 
$28

$35

$35

0.125

 
$35

$28

$28

0.125

 
$35

$28

$35

0.125

 
$35

$35

$28

0.125

 
$35

$35

$35

0.125

The expected price paid is
.
Suppose that bidders 1 and 2 collude and would be willing to bid up to a maximum of their values, but the two bidders would not be willing to bid against each other. The probabilities of the combinations of bidders are still all equal to 0.125. Continue to assume that the winning bidder must pay a price equal to the second highest bid. 
On the following table, indicate the price paid by the winning bidder.
   
Maximum    of Bidder 1 and 2

Bidder    3 Value

Probability

Price
 
($)

($)
 
$28

$28

0.125

 
$28

$35

0.125

 
$35

$28

0.125

 
$35

$35

0.125

 
$35

$28

0.125

 
$35

$35

0.125

 
$35

$28

0.125

 
$35

$35

0.125

With collusion, the expected price paid is
2 . Individual Problems 18-2
A reserve price is a minimum price set by the auctioneer. If no bidder is willing to pay the reserve price, the item is unsold at a profit of $0 for the auctioneer. If only one bidder values the item at or above the reserve price, that bidder pays the reserve price. An auctioneer faces two bidders, each with a value of either $36 or $96, with both values equally probable. Without a reserve price, the second highest bid will be the price paid by the winning bidder.
The following table lists the four possible combinations of bidder values. Each combination is equally likely to occur.
On the following table, indicate the price paid by the winning bidder with and without the stated reserve price.
   
Bidder    1 Value

Bidder    2 Value

Probability

Price    Without Reserve

Price    with $96 Reserve Price
 
($)

($)

($)
 
$36

$36

0.25

 
$36

$96

0.25

 
$96

$36

0.25

 
$96

$96

0.25

Without a reserve price, the expected price is
. With a reserve price of $96, the expected price is
. Thus, the expected price is larger with or without    the reserve price.
3 . Individual Problems 18-3
A reserve price is a minimum price set by the auctioneer. If no bidder is willing to pay the reserve price, the item is unsold at a profit of $0 for the auctioneer. If only one bidder values the item at or above the reserve price, that bidder pays the reserve price. An auctioneer faces two bidders, each with a value of either $228 or $304, with both values equally probable. Without a reserve price, the second highest bid will be the price paid by the winning bidder.
The following table lists the four possible combinations for bidder values. Each combination is equally likely to occur.
On the following table, indicate the price paid by the winning bidder with and without the stated reserve price.
   
Bidder    1 Value

Bidder    2 Value

Probability

Price    Without Reserve

Price    with $304 Reserve Price
 
($)

($)

($)
 
$228

$228

0.25

 
$228

$304

0.25

 
$304

$228

0.25

 
$304

$304

0.25

Without a reserve price, the expected price is
. With a reserve price of $304, the expected price is
. Thus, the expected price is larger with or without    the reserve price.
4 . Individual Problems 18-4
In Sweden, firms that fail to meet their debt obligations are immediately auctioned off to the highest bidder. (There is no reorganization through Chapter 11 bankruptcy.) The current managers are often the high bidders for the company. (Hint: Assume these auctions are common-value auctions.)
Suppose for a particular auction, the current managers have placed a bid of $10 million.
True or False: To avoid the winner’s curse, your bid should be larger than $10 million.
True
False
5 . Individual Problems 18-5
When a famous painting becomes available for sale, it is often known which museum or collector will be the likely winner. Yet, the auctioneer actively woos representatives of other museums that have no chance of winning to attend anyway.
Suppose a piece of art has recently become available for sale and will be auctioned off to the highest bidder, with the winner paying an amount equal to the second highest bid. Assume that most collectors know that Darnell places a value of $100,000 on the art piece and that he values this art piece more than any other collector. Suppose that if no one else shows up, Darnell simply bids $100,0002=$50,000
and wins the piece of art.
The expected price paid by Darnell, with no other bidders present, is
.
Suppose the owner of the artwork manages to recruit another bidder, Felix, to the auction. Felix is known to value the art piece at $80,000.
The expected price paid by Darnell, given the presence of the second bidder Felix, is
.
6 . Individual Problems 18-6
Rina Green estimates the cost of future projects for a large contracting firm. Rina uses precisely the same techniques to estimate the costs of every potential job and formulates bids by adding a standard profit markup. For some companies, to which the firm offers its services, there are no competitors also seeking their business, so Rina’s company is almost certain to get these companies as clients. For these jobs, Rina finds that her cost estimates are right, on average. For jobs where competitors are also vying for the business, Rina finds that they almost always end up costing more than she estimates.
True or False: Rina is less likely to win the jobs where she underestimates the costs, causing her to experience the winner’s curse.
True
False
7 . Individual Problems 19-1
In the late 1990s, car leasing was very popular in the United States. A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car. If the customer decided to keep the car, the customer would pay a price to the manufacturer, the “residual value,” computed as 60% of the new car price. The manufacturer would then sell the returned cars at auction. In 1999, manufacturers lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value).
Suppose two customers have leased cars from a manufacturer. Their lease agreements are up, and they are considering whether to keep (and purchase at 60% of the new car price) their cars or return their cars. Two years ago, Becky leased a car valued new at $10,000. If she returns the car, the manufacturer could likely get $7,000 at auction for the car. Clancy also leased a car, valued new at $17,000, two years ago. If he returns the car, the manufacturer could likely get $8,670 at auction for the car.
Use the following table to indicate whether each buyer is more likely to purchase or return the car.
   
Buyer

Keep    and Purchase Car

Return    Car
 
Becky

 
Clancy

The manufacturer will lose money (at auction, relative to the residual value of the car) if Becky or Clancy    returns the car instead of keeping and purchasing it.
True or False: Setting a more accurate residual price of each car would help attenuate the problems of adverse selection.
True
False
8 . Individual Problems 19-2
Many police officer positions require the applicant to have a college degree, even though the tasks of a police officer rarely call upon college course material.
Suppose two individuals who do not have college degrees are considering applying to the police force. Teresa is considering applying for an officer position and plans on working for the police force for a period of time, over which she would earn approximately $1,200,000 (in present discounted value) in earnings while in the position. Andrew is also considering applying, and plans on working as an officer for a period of time, over which he would earn approximately $4,000 (in present discounted value) in lifetime earnings while in the position. Also suppose that present value of obtaining a college degree, which is required to submit a job application to the police department, is $100,000. 
Use the following table to indicate whether each individual would likely apply, or not, given the cost of obtaining a college degree.
   
Buyer

Would    Apply

Would    Not Apply
 
Teresa

 
Andrew

9 . Individual Problems 19-3
Suppose that you sell bicycle theft insurance and bicycle owners do not know whether they are high- or low-risk consumers.
True or False: This situation causes an adverse selection problem, but only if the person is a low-risk consumer.
True
False
10 . Individual Problems 19-4
When China reformed state-owned enterprises, it tried a new approach to choosing managers: it put managerial jobs up for auction. The bids for the jobs consisted of promises of future profit streams that the managers would generate and then deliver to the state. In cases where the incumbent manager was the winning bidder, firm productivity tended to increase dramatically. When outside bidders won, there was little productivity improvement. Assume that incumbent managers and new managers had similar qualifications.
True or False: This result stems from information asymmetry between incumbent managers and outside bidders.
True
False
11 . Individual Problems 19-5
Soft selling occurs when a buyer is skeptical of the usefulness of a product and the seller offers to set a price that depends on realized value. For example, suppose a sales representative is trying to sell a company a new accounting system that will, with certainty, reduce costs by 20%. However, the customer has heard this claim before and believes there is only a 30% chance of actually realizing that cost reduction and a 70% chance of realizing no cost reduction.
Assume the customer has an initial total cost of $300.
According to the customer’s beliefs, the expected value of the accounting system, or the expected reduction in cost, is
.
Suppose the sales representative initially offers the accounting system to the customer for a price of $39.00.
The information asymmetry stems from the fact that the sales rep or buyer    has more information about the efficacy of the accounting system than does the sales rep or buyer    . At this price, the customer will or will not    purchase the accounting system, since the expected value of the accounting system is greater or less    than the price.
Instead of naming a price, suppose the sales representative offers to give the customer the product in exchange for 50% of the cost savings. If there is no reduction in cost for the customer, then the customer does not have to pay.
True or False: This pricing scheme alleviates some of the information asymmetry that is present in this scenario.
True
False
12 . Individual Problems 19-6
You need to hire some new employees to staff your startup venture. You know that potential employees are distributed throughout the population as follows, but you can’t distinguish among them:
   
Employee Value

Probability
 
$60,000

0.125
 
$69,000

0.125
 
$78,000

0.125
 
$87,000

0.125
 
$96,000

0.125
 
$105,000

0.125
 
$114,000

0.125
 
$123,000

0.125
The expected value of hiring one employee is
.
Suppose you set the salary of the position equal to the expected value of an employee. Assume that employees will not work for a salary below their employee value.
The expected value of an employee who would apply for the position, at this salary, is
.
Given this adverse selection, your most reasonable salary offer (that ensures you do not lose money) is 60,000, 69,000, 78,000 or 87,000    .
13 . Individual Problems 20-1
Your product fails about 2% of the time, on average. Some customers purchase the extended warranty you offer in which you will replace the product if it fails. Suppose that you have currently set the price of the extended warranty at 2% of the product price.
An analyst at your company argues that the types of customers who purchase the extended warranty are more likely to misuse and break the product. However, the analyst argues, the company cannot accurately identify these types of customers.
The analyst is claiming that adverse selection or morale hazard    will cause the claim rate to be higher or lower    than 2%.
True or False: You should set the price of the extended warranty at less than 2% of the product price.
True
False
14 . Individual Problems 20-2
A colleague tells you that he can get a business loan from the bank, but the rate seems very high for what your colleague considers a low-risk loan.
Use the following table to classify each explanation for the high rate as an instance of either adverse selection or moral hazard.
   
Explanation    for High Rate

Adverse    Selection

Moral    Hazard
 
The bank cannot determine which   borrowers are likely to pay back the loan and which are likely to default.

 
The bank believes your friend, if   given access to financing at low rates, would use the money frivolously.

You advise your friend to disclose all of his past financial records and credit history to the bank to show that he is likely to pay back the loan.
Your advice is more likely to solve the problem of adverse selection or moral hazard    .
15 . Individual Problems 20-3
Lightweight personal locator beacons are now available to hikers, making it easier for the Forest Service’s rescue teams to locate those lost or in trouble in the wilderness.
True or False: Forest Service costs will likely fall due to moral hazard.
True
False
16 . Individual Problems 20-4
Suppose that every driver faces a 3% probability of an automobile accident every year. An accident will, on average, cost each driver $9,000. Suppose there are two types of individuals: those with $45,000.00 in the bank and those with $4,500.00 in the bank. Assume that individuals with $4,500.00 in the bank declare bankruptcy if they get in an accident. In bankruptcy, creditors receive only what individuals have in the bank. Assume that both types of individuals are only slightly risk averse.
In this scenario, the actuarially fair price of full insurance, in which all damages are paid by the insurance company, is
.
Assume that the price of insurance is set at the actuarially fair price.
At this price, drivers with $45,000.00 in the bank likely will or will not    buy insurance, and those with $4,500.00 in the bank likely will or will not    buy insurance. (Hint: For each type of driver, compare the price of insurance to the expected cost without insurance.)
Suppose a state law has been passed forcing all individuals to purchase insurance at the actuarially fair price.
True or False: The law will affect the behavior of both types of drivers.
False
True
17 . Individual Problems 20-5
BPO Services is in the business of digitizing information from forms that are filled out by hand. In 2006, a big client gave BPO a distribution of the forms that it digitized in house last year, and BPO estimated how much it would cost to digitize each form.
   
Form    Type

Mix    of Forms

Form    Cost
 
A

0.5

$0.75
 
B

0.5

$0.25
The expected cost of digitizing a form is
.
Suppose the client and BPO agree to a deal, whereby the client pays BPO to digitize forms. The price of each form processed is equal to the expected cost of the form that you calculated in the previous part of the problem.
Suppose that after the agreement, the client sends only forms of type A.
The expected digitization cost per form of the forms sent by the client is
. This leads to an expected loss of
per form for BPO. (Hint: Do not round your answers. Enter the loss as a positive number.)
18 . Individual Problems 20-6
Frequent flyer programs are targeted more toward business travelers (who do not pay for their own tickets) than leisure travelers (who do). 
True or False: Leisure travelers are more likely than business travelers to choose an airline primarily based on the frequent flyer program.
False
True

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