Recall that in an expected utility model with a good (g) and bad (b) state of...

 

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Recall that in an expected utility model with a good (g) and bad (b) state of nature, preferences over state-contingent consumption bundles (cg, cb) are represented by the utility function. EU (cg, cb) = (1-p)U(cg)+pU (cb) for some function U, where p is the probability of the bad state occurring. Suppose that Bob has preferences given by (1) with U (c) = √c, and that in the absence of insurance his consumption would be (cg. cb) = (14, 5). In other words, the loss/damage Bob faces in the bad state is 9 consumption units. Suppose that p = 1/5 and that an insurance company offers Bob the state-contingent consumption bundle (-t, 5t-t), where t > 0 is the premium Bob chooses to pay and 5t is the amount of insurance coverage he receives in the bad state. That is, Bob can choose to add (-t. 5t-t) of consumption to his current consumption. What will his state-contingent consumption be after he purchases t units of this contract? Recall that in an expected utility model with a good (g) and bad (b) state of nature, preferences over state-contingent consumption bundles (cg, cb) are represented by the utility function. EU (cg, cb) = (1-p)U(cg)+pU (cb) for some function U, where p is the probability of the bad state occurring. Suppose that Bob has preferences given by (1) with U (c) = √c, and that in the absence of insurance his consumption would be (cg. cb) = (14, 5). In other words, the loss/damage Bob faces in the bad state is 9 consumption units. Suppose that p = 1/5 and that an insurance company offers Bob the state-contingent consumption bundle (-t, 5t-t), where t > 0 is the premium Bob chooses to pay and 5t is the amount of insurance coverage he receives in the bad state. That is, Bob can choose to add (-t. 5t-t) of consumption to his current consumption. What will his state-contingent consumption be after he purchases t units of this contract?

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ANS WER Bob s state cont ing ent consumption after he purchas... View the full answer