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## Economics 103 Problem Set 3

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 personâs name
be accepted only by special arrangement.
Staple pages together. Be sure to

Total 20 points.

1)
(7 points)Insuranceand social
policy
You are
making a movie with a 20% chance of making a ton-load of money, and 80% chance of earning nothing. Your utility is the square root of income (Utility
= Y1/2); you will have \$1,000,0001/2 happiness if your movie
succeeds but 01/2 happiness if it fails.

a) (1 point) What is the expected value
that income?
Note that in EXCEL, the square root
function is â=X^.5â 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
successfulmovie 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.)
part A, in general, why do people buy insurance? How can insurance companies profit? What happens to expected utilitywhen people can buy insuranceat 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,nurses and doctors.
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 becomingdoctors. Show the effects of discrimination on
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 nurses,
and a separate for doctors.)
c)
(1 point) Wanting higher wages, nurses successfully
lobby government to crack down on discrimination practices. If discrimination
is eliminated, show the changes that will take place in the labor markets for nurses
and doctors. Who benefits and who loses from the ban on discrimination?

d)
(1
point) Are there circumstances where the government should notprevent discrimination?

3)
(4
points) Long-run competition. Most of the cost of a new phone is in the
research and development and in building production facilities. By contrast,
the marginal cost of producing another phone is relatively low, even minimal.
a)
(1
points) You have been hired by Samsungto
recommend pricing and marketing strategies for a new phone. On one graph: Draw a hypothetical Average
Total Cost (ATC) curve, the Marginal Cost curve, and a Demand (MU) curve for the
phone. (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 phones
as the difference between average total cost and the average revenue (or the price). (Note
that Samsungâs profit is the number of phones sold times price minus ATC.)What
will happen to the price of IPhones and Apple sales and profits when Samsung
comes out with a new phone? 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 Samsung 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 â ATC)*Q). How
does this change consumer, producer, and total surplus?
d)
(1
point) Discuss at least three strategies Samsungcould
follow to give it more monopoly power and allow it to raise prices.

4)
(4
points) Health insurance. Read Gerald Friedman, âUniversal Health
Care: Can we afford anything less?â(Real
World Micro,8.6):
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?

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