Suppose an individual has the following utility function defined over wealth: u(w) = w. The individual has an initial wealth level of $20,000.

a. The individual has a 20% chance of a heart attack and the monetary loss associated with the attack is $5,000.

i. What is the expected monetary loss from a heart attack?

ii. What is the maximum amount this individual is willing to pay for insurance against a heart attack?

iii. What is the risk premium?

b. A new drug has been developed that is effective in preventing heart attacks. Taking the drug reduces the chance of a heart attack to 10%, but the loss associated with the attack increases to $10,000.

i. Now what is the expected loss?

ii. What is the maximum amount this individual is willing to pay for insurance against a heart attack?

iii. What is the risk premium?

c. Explain why some of the answers change before and after the individual begins taking the drug.