7 . 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
$50,000	0.1
$55,000	0.1
$60,000	0.1
$65,000	0.1
$70,000	0.1
$75,000	0.1
$80,000	0.1
$85,000	0.1
$90,000	0.1
$95,000	0.1

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/$55,000/$50,000/$65,0000.

8 . 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 $10,000. Suppose there are two types of individuals: those with $60,000.00 in the bank and those with $5,000.00 in the bank. Assume that individuals with $5,000.00 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 $60,000.00 in the bank likely will/will not buy insurance, and those with $5,000.00 in the bank likely will/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 only the behavior of drivers with $5,000.00 in the bank.

True

False