Suppose James is considering buy a medical insurance for the next year. His income in the next year will be $1,000,000 HKD. But he may be in sick with a probability of 5%, and if he is sick in the next year, it will cost him $300,000 HKD for the medical treatment. Suppose that James' utility function is , where W is James' net income in the next year. 

 

a) Calculate James' expected utility for the next year.

b) Now suppose an insurance company is offering a medical insurance contract to James, and the insurance can cover all of the medical cost $300,000 HKD. If the insurance contract is actuarially fair, what is the premium in dollar amount? Without any calculation, answer and explain whether James would be better by purchasing this insurance? 

  

c) Let us assume the premium equal $20,000 HKD. Should James buy this insurance based on the framework of Expected Utility? (You need to show your calculation here) 

 

d) Due to the outbreak of COVID-19, now suppose that the probability of being sick decreases to 3% for James (thanks to social distancing). All other conditions remain the same. Without any calculation, answer whether James should buy the insurance policy described. Briefly explain the economic reasoning of your answer. 

Answer rating: 100% (QA)

a James expected utility for the next year can be calculated as follows If James is not sick His net ... View the full answer