C79 -- Homework 7

Due date: April 2, at the beginning of class at 2:10pm

Homeworks must be turned in on paper (hard-copy), at the start of
class.  Late homeworks (i.e. submitted after 2:10pm) will NOT be
accepted.


Q1) If you swim in Florida or surf in southern California, you've
probably heard about the risk of shark attack -- there's been a lot
of media attention about past shark attacks.  In practice, the risk
is pretty small: on average, there's one fatality reported about
every other year or so in the US (and about 15 or so non-fatal shark
attacks each year).  More people die each year from a vending machine
falling on them than from shark attacks; and something like 100
times as many people drown each year as the number who die due to
shark attack.  Nonetheless, some people remain pretty concerned
about the risk of shark attack.  Name one cognitive bias that might
cause members of the public to over-estimate the risk of shark
attacks.


Q2) If you listen to late-night TV, you might see an infomercial for,
say, ginsu knives.  After pitching its benefits, at the end the
salesman might ask the audience, "How much would this knife set be
worth to you?  $100?  $200?  Well, get ready for this -- you can
have it for just $39.99!"  What cognitive bias is he trying to
exploit in the audience, to get them to buy a knife set?



Q3) Background: After the recent disaster at the Fukushima nuclear
reactor, there was significant public concern about the risks due to
radiation emitted during the reactor collapse -- many Americans in
Japan evacuated the country, and some Californians went so far as to
take iodine tablets to protect themselves against radiation, even
though scientists said that the radiation levels away from the reactor
posed very little risk.  One public health study found that in the
past 40 years, melanoma skin cancer increased by 4-8x among people
18-39, apparently due to increased use of tanning beds.  Name one
cognitive bias that might explain why people might over-estimate the
risks due to radiation from the Fukushima reactor, and under-estimate
the risks due to use of tanning beds.


Q4) If you ask people which risk feels scarier, nuclear radiation, beer,
pesticides, many people will probably pick the radiation or the
pesticides.  However, scientists have found that beer (or alcohol
of any kind) probably causes far more cancer than nuclear radiation
or pesticides (one recent estimate suggests that perhaps 10% of all
cancers in men are caused by alcohol).

(a) Name one cognitive bias that might explain why people might
over-estimate the risk of cancer from nuclear radiation.

(b) Name one cognitive bias that might explain why people might
under-estimate the risks from beer.

Q5) Arrow in his classic article on health care economics describes
the various way that health care markets differ from ordinary markets.
Some of these different features are shared by many insurance markets
and some are relatively unique to health care. For example, think
about health insurance and insurance for cell phones. Name at least
one feature described by Arrow that both markets have in common and
two that they do not.

Q6) Let us examine a stylized market in used cars.

First, imagine that there are two types of used cars: gems and lemons.
Gems have been well maintained, are unlikely to need any repair, and
are high quality cars. Lemons are not been well maintained, are likely
to require some repair work, and are low quality cars. Both types of
cars are equally common. A car drawn at random with equal probability
has a 50% chance of being a lemon. 

Second, buyers have an equal chance of buying gems or lemons because
they have no way of knowing which is which until after they have
purchased the car and an equal number of both cars are for sale. If
buyers have complete information about the quality of the cars, then
they would be willing to pay $20,000 for a gem and only $5,000 for a
lemon.

(a) How much should buyers be willing to pay for a used car in this
world if buyers are willing to pay their expected value?

Let us change this market a bit. Imagine that sellers know if they
have gems or lemons and they know how much their cars are worth. The
seller of a gem knows it is worth $20,000 and the seller of a lemon
knows that it is worth $5,000.

(b) If sellers knows if their cars are gems or lemons, what kind of
cars will be offered for sale?

(c) What kind of problem that we have discussed in class does this
market suffer from?

(d) In one sentence describe a law the government could enact or
something that sellers themselves could do that would improve this
market?