Author Question: Glen's friend Andre is a big strong guy. Andre will not allow anyone to harm Glen. Glen enjoys ... (Read 62 times)

K@ · **on:** Jul 1, 2018

Glen's friend Andre is a big strong guy. Andre will not allow anyone to harm Glen. Glen enjoys teasing people. In fact, Glen's marginal benefit of teasing people is given by: MB(Q) = 75 - 10Q. Generally, people do not enjoy Glen teasing them.

Thus, they retaliate to Glen's teasing. Without Andre around to protect Glen from the retaliation, Glen's marginal cost of teasing people is MC(Q) = 20Q due to the retaliation. However, with Andre around, Glen perceives his marginal costs of teasing to always be zero as no one will retaliate with Andre around. This is because Andre will step in to protect Glen from retaliation. Without Andre around, what is Glen's choice for teasing? How much does Glen increase teasing when Andre's around? Is Glen's behavior characteristic of a moral hazard or adverse selection?

Question 2

The authors note that an appropriate discount rate for most U.S. households is near 5. However, suppose you are considering the decision to attend graduate school, and you already have large credit card balances from your undergraduate years.

If you decide to use a higher discount rate (e.g., 10) to reflect your higher opportunity cost of money, what impact does this change in the discount rate have on the net present value of a graduate degree? A) Increases NPV
B) Decreases NPV
C) NPV would not change as long as we use nominal costs and returns.
D) NPV may increase or decrease, and we cannot determine the direction of change without more information.

phuda · **Reply #1 on:** Jul 1, 2018

Answer to Question 1

Without Andre around, Glen will set: MB(Q) = MC(Q) 75 - 10Q = 20Q Q = 2.5. If Andre is present, Glen sets: MB(Q) = 0 75 - 10Q = 0 Q = 7.5. Thus, Glen increases his teasing activities by 5 units. In this scenario, Andre is like an insurance policy for Glen. When Glen has his insurance, he increases the activity that triggers payment by the insurer. Thus, Glen's behavior is characteristic of a moral hazard.

Answer to Question 2

B