Suppose that after university there is an 80% chance Jeff will secure a job that pays $48,400 for the year. However there is a 20% chance that Jeff will not find a job in the year and Jeff will only earn unemployment benefits of $12,100 in the year.

a) What is Jeff’s expected income in the upcoming year?

b) What is the standard deviation of Jeff’s income in the upcoming year?

c) If Jeff’s utility function for income after any payments is given by U=?W, what is Jeff’s expected utility for next year’s income? What income for certain would provide Jeff with the same level of utility?

d) What is Jeff’s risk premium and the cost of the risk to Jeff? Interpret their meaning.

e) If a firm was offering unemployment insurance, that will ensure Jeff earn $48,400, but that Jeff must pay $8400, would Jeff take it? Would a risk neutral person take the unemployment insurance?

f) Suppose that there are other workers with same utility function and situation as Jeff except that the chance they will become unemployed is q? What is the smallest value of q so that a decision maker purchases insurance for $8400?

Answer rating: 100% (QA)

a Expected Income 41140 b Standard Deviation 48400 12100 12100 48400 2566798 c Expected Utility expe... View the full answer