A risk averse individual faces uncertainty with two outcomes: good, bad. The individual has income $560...

  

Transcribed Image Text:

A risk averse individual faces uncertainty with two outcomes: good, bad. The individual has income $560 under good and $350 under bad outcome. The probability of good outcome is 4/7 (so the probability of bad outcome is 1- 4/7 = 3/7). The individual can buy an non-negative x units of insurance. Every unit of insurance has price Sp and it pays $1 in the ev of bad outcome. In this insurance market, the unit price of insurance is known to be p = 1/2. (a) [2 points] Determine if the insurance market is competitive or not. (b) [6 points] Suppose the individual buys x units of insurance. Determine the individual's net income under good income, net income under bad income and the average net income. Draw these three in a diagram as functions of x. (c) [6 points] For the individual: (i) compare full insurance with over insurance and (ii) compa full insurance with partial insurance. Then determine best choice of insurance for the individu: A risk averse individual faces uncertainty with two outcomes: good, bad. The individual has income $560 under good and $350 under bad outcome. The probability of good outcome is 4/7 (so the probability of bad outcome is 1- 4/7 = 3/7). The individual can buy an non-negative x units of insurance. Every unit of insurance has price Sp and it pays $1 in the ev of bad outcome. In this insurance market, the unit price of insurance is known to be p = 1/2. (a) [2 points] Determine if the insurance market is competitive or not. (b) [6 points] Suppose the individual buys x units of insurance. Determine the individual's net income under good income, net income under bad income and the average net income. Draw these three in a diagram as functions of x. (c) [6 points] For the individual: (i) compare full insurance with over insurance and (ii) compa full insurance with partial insurance. Then determine best choice of insurance for the individu:

Answer rating: 100% (QA)

1 a The insurance market price is 12 a unit which means that all organizations must stick to this ma... View the full answer