INTERMEDIATE MICROECONOMICS INSTRUCTOR: MSc.

NGUYEN VIET HOA

CHAPTER 2: CHOICE UNDER RISK AND UNCERTAINTY

1. A situation in which a decision maker is totally sure about the outcome is called
A. Risk
B. Certainty
C. Uncertainty
D. Diversification
2. A situation in which a decision maker must choose between strategies that have more
than one possible outcome when the probability of each outcome is unknown is
A. Risk
B. Certainty
C. Uncertainty
D. Diversification
3. A situation in which a decision maker must choose between strategies that have more
than one possible outcome but he knows all of the possible outcomes of a decision and
also knows the probability associated with each outcome is referred to as
A. Risk
B. Certainty
C. Uncertainty
D. Diversification
4. In the model of decision making under different conditions, what is the difference
between risk and uncertainty?
A. Under risk, probabilities can be measured; under uncertainty, they cannot.
B. Under risk, there is a well-defined problem; under uncertainty, the definition is unclear.
C. Under risk, choices are clear and the chances of different outcomes can be measured;
under uncertainty, neither applies.
D. Under risk, information is reliable; under uncertainty, it is not.
5. Which of the following does not measure risk?
A. Coefficient of variation
B. Standard deviation
C. Expected value
D. All of the above are measures of risk.
6. The weighted average of all possible outcomes of a project, with the probabilities of the
outcomes used as weights, is known as the

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A. Variance.
B. Standard deviation.
C. Expected value.
D. Coefficient of variation.
7. The sum of the utilities from each possible outcome of a situation weighted by the
probability of that outcome is called
A. expected utility.
B. total utility.
C. marginal utility.
D. expected value.
8. The coefficient of variation measures
A. The risk per unit of expected payoff.
B. The risk-adjusted expected value.
C. The payoff per unit of risk.
D. A decision maker's risk-return tradeoff.
9. Consider the following game. You roll a six-sided die and each time you roll a 6, you
get $30. For all other outcomes you pay $6. The expected value of the game is ________ .
A. -$6
B. $0
C. $6
D. $30
10. Consider the following game. You pick a card from a deck and each time you select
an ace, you get $260. For all other cards pay $13. The expected value of the game is
A. -$12
B. $0
C. $8
D. $32
11. Calculate standard deviation of total revenue in the following table
Total revenue (thousand USD) Probability
20 0,2
25 0,3
30 0,4
35 0,1

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E(X)=20(0.2)+25(0.3)+30(0.4)+35(0.1)=27= Mean
A. 14,2 Var(X)= (27-20)^2*0,2+....

standard deviation= căn Var(X)

B. 15,2
C. 27
D. None of the above
12. Aline and Sarah decide to go into business together as economic consultants. Aline
believes they have a 50-50 chance of earning $200,000 a year, and that if they don't, they'll
earn $0. Sarah believes they have a 75% chance of earning $100,000 and a 25% chance
of earning $10,000. The expected value of the undertaking,
A. According to Sarah, is $100,000.
B. According to Aline, is $100,000.
C. According to Aline, is $200,000.
D. None of the above.
13. Assume that one of two possible outcomes will follow a decision. One outcome yields
a $75 payoff and has a probability of 0.3; the other outcome has a $125 payoff and has a
probability of 0.7. In this case the expected value is
A. $85.
B. $60.
C. $110.
D. $35.
14. Randy and Samantha are shopping for new cars (one each). Randy expects to pay
$15,000 with 1/5 probability and $20,000 with 4/5 probability. Samantha expects to pay
$12,000 with 1/4 probability and $20,000 with 3/4 probability. Which of the following is
true?
A. Randy has a higher expected expense than Samantha for the car.
B. Randy has a lower expected expense than Samantha for the car.
C. Randy and Samantha have the same expected expense for the car, and it is somewhat
less than $20,000.
D. Randy and Samantha have the same expected expense for the car: $20,000.
15. Randy and Samantha are shopping for new cars (one each). Randy expects to pay
$15,000 with 1/5 probability and $20,000 with 4/5 probability. Samantha expects to pay
$12,000 with 1/4 probability and $20,000 with 3/4 probability. Randy's expected expense
for his car is
A. $20,000.

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B. $19,000.
C. $18,000.
D. $17,500.
16. A person with a diminishing marginal utility of income
A. Will be risk neutral.
B. Will be risk loving.
C. Will be risk averse.
D. Cannot decide without more information
17. If a person's utility doubles when their income doubles, then that person is
A. Risk averse
B. Risk neutral
C. Risk loving
D. There is not enough information given in the question to determine an answer.
18. The concept of a risk premium applies to a person that is
A. Risk averse.
B. Risk neutral.
C. Risk loving.
D. None of the above.
19. John Brown's utility of income function is U = 3I2, where I represents income. From
this information you can say that
A. John Brown is risk neutral.
B. John Brown is risk loving.
C. John Brown is risk averse.
D. We need more information before we can determine John Brown's preference for risk.
20. An individual has utility function U = I + 5√𝐈. This person is
A. Risk averse
B. Risk loving
C. Risk neutral
D. Not enough information to conclude
21. For risk-averse individuals, as their income increases, their utility from that income
A. increases at an increasing rate.
B. decreases at a decreasing rate.
C. increases at a decreasing rate.

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D. decreases at an increasing rate.

22. For risk lovers, as their income increases, their utility from that income
A. decreases at an increasing rate.
B. increases at an increasing rate.
C. decreases at a decreasing rate.
D. increases at a decreasing rate.
23. For risk-neutral individuals, as their income increases, their utility from that income
A. increases at a constant rate.
B. increases at an increasing rate.
C. increases at a decreasing rate.
D. decreases at an increasing rate.
24. Which of the following methods of selecting a strategy is consistent with risk averse
behavior?
A. If two strategies have the same expected profit, select the one with the smaller standard
deviation.
B. If two strategies have the same standard deviation, select the one with the smaller
expected profit.
C. Select the strategy with the larger coefficient of variation.
D. All of the above are correct.
25. Assume that two investment opportunities have identical expected values of $100,000.
Investment A has a variance of 25,000, while investment B's variance is 10,000. We would
expect most investors (who dislike risk) to prefer investment opportunity
A. A because it has less risk.
B. A because it provides higher potential earnings.
C. B because it has less risk.
D. B because of its higher potential earnings.
26. Assume that two investment opportunities have identical expected values of $100,000.
Investment A has a variance of 25,000, while investment B's variance is 10,000. If an
investor prefers A over B, he is
A. Risk averse
B. Risk neutral
C. Risk loving
D. None of the above

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27. Strategy A has an expected value of 10 and a standard deviation of 3. Strategy B has
an expected value of 10 and a standard deviation of 5. Strategy C has an expected value
of 15 and a standard deviation of 10. Which one of the following statements is true?
A. A risk averse decision maker will always prefer A to B, but may prefer C to A.
B. A risk neutral decision maker will always prefer C to A or B.
C. A risk seeking decision maker will always prefer C to A or B.
D. All of the above are correct.
28. If a decision maker is risk averse, then the best strategy to select is the one that yields
A. Highest expected payoff
B. Lowest coefficient of variation
C. Highest expected utility
D. Lowest standard deviation
29. The marginal utility of money diminishes for a decision maker who is
A. Risk lover
B. Risk neutral
C. Risk averse
D. In a situation of uncertainty
30. Alice has the total ulitily curve of income as shown in the
graph. What is Alice’s attitude toward risk?
A. Risk averse
B. Risk neutral
C. Risk loving
D. None of the above
31. (Continue question 30) In the diagram above, CF is called
A. Standard deviation
B. Expected damage
C. Risk premium
D. Insurance premium
32. The maximum amount of money that a risk-averse person will pay to avoid taking a
risk is known as the
A. Payoff.
B. Risk premium.
C. Expected loss.

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D. Expected value.
33. Risk premium is the gap between
A. Expected income and expected loss
B. Expected loss and certainty equivalent
C. Expected utility and certainty equivalent
D. Expected income and certainty equivalent
34. Alice’s utility function is U = √𝟔𝐈 in which I is annual income. Alice is facing a job
with probability 40% of earning $9000 and 60% of earning 16000$. In order to make
Alice accept this job, employer should offer her a certain income of
A. 11560$
B. 11800$
C. 12960$
D. 13200$
35. For risk lovers, total utility curve if income is
A. Convex to the origin
B. Concave to the origin
C. Convex to the horizontal axis
D. Concave to the horizontal axis
36. Mark has two job offers when he graduates from college. Mark views the offers as
identical, except for the salary terms. The first offer is at a fixed annual salary of $45,000.
The second offer is at a fixed salary of $25,000 plus a possible bonus of $40,000. Mark
believes that he has a 50-50 chance of earning the bonus. If Mark takes the offer that
maximizes his expected utility and he is risk loving, then
A. Mark will take the first offer.
B. Mark will take the second offer.
C. Mark is indifferent between the offers because both yield the same expected utility.
D. Indeterminate from the given information, we cannot say what Mark will do.
37. (Continue question 30) If Mark takes the offer that maximizes his expected utility and
he is risk neutral, then
A. Mark will take the first offer.
B. Mark will take the second offer.
C. Mark is indifferent between the offers because both yield the same expected utility.
D. Indeterminate from the given information, we cannot say what Mark will do.
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38. The person who buys insurance would have the total utility curve of income
A. Convex to the origin
B. Concave to the origin
risk averse
C. Convex to the horizontal axis
D. Concave to the horizontal axis
39. The minimum insurance premium equals to
A. The gap between expected value and certainty equivalent
B. The gap between total value of assets and expected value
C. The gap between total value of assets and expected loss
D. The gap between total value of assets and certainty equivalent
40. The maximum insurance premium that an individual is willing to pay for equals to
A. The gap between expected value and certainty equivalent
B. The gap between total value of assets and expected value
C. The gap between total value of assets and expected loss
D. The gap between total value of assets and certainty equivalent
41. An individual has utility function U = W0,5 (W is the total value of assets). Her assets
include an apartment which worth 3 billion dongs and a car which worth 500 million
dongs. The probability of losing the car is 15%. The minimum insurance premium for
this individual is Expected loss=p(loss)×amount of loss

A. 0,75 billion dongs =0.15×500=75 million VND

The minimum premium is the expected loss
B. 7,5 million dongs
C. 75 million dongs
D. 750 million dongs
42. An individual who has 2 billion dongs is facing the risk of losing 100 million dongs
with 10% probability. The minimum insurance premium for this individual is
A. 0,1 million dongs
B. 1 million dongs
C. 10 million dongs
D. 100 million dongs
43. Assume that inflation remains unchanged, bank deposit with fixed interest rate is
A. Safe asset
B. Risky asset
C. Both A and B are correct

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D. Both A and B are incorrect

44. If you are careless when you use gas because you know that you have bought fire
insurance for your house then this is an example of
A. Free-rider
B. Moral hazard
C. Adverse selection
D. Symmetric information
45. After purchasing anti-theft insurance, you decide to buy fewer security equipments
which protect your home. This is an example of
A. Free-rider
B. Moral hazard
C. Adverse selection
D. Symmetric information
46. Residents in areas where there are a lot of crime tend to buy more anti-theft insurance
than those in areas with good security. This is an example of
A. Free-rider
B. Moral hazard
C. Adverse selection
D. Symmetric information
47. With regard to risk averse individuals, indifference curve which represents the
relationship between expected income and the level of risk is
A. Vertical
B. Horizontal
C. Upward sloping
D. Downward sloping
48. With regard to risk lovers, indifference curve which represents the relationship
between expected income and the level of risk is
A. Vertical
B. Horizontal
C. Upward sloping
D. Downward sloping
49. With regard to risk neutral individuals, indifference curve which represents the
relationship between expected income and the level of risk is

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A. Vertical
B. Horizontal
C. Upward sloping
D. Downward sloping
50. Which of the following is a way to deal with decision making under uncertainty?
A. Simulation
B. Diversification
C. Acquisition of additional information
D. Application of the maximin criterion

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