1. Purchasing Insurance: Suppose that the household has the utility function u(c) = log(c). The household also possess wealth m = $1000 and in the event of an auto accident, the household will face a loss of L = $400. Additionally, the household believes that there is a 25% chance that they will be in an accident each year. Suppose that the auto insurance by the household is considered fair. The household is trying to decide how much auto insurance (K) to buy. (d) Find the optimal level of insurance. (e) Suppose that the insurance is not fair, so that y = 0.4. Show that the household will consume less in the accident state than in the now accident state.

1. Purchasing Insurance: Suppose that the household has the utility function u(c) = log(c). The household also possess wealth m = $1000 and in the event of an auto accident, the household will face a loss of L = $400. Additionally, the household believes that there is a 25% chance that they will be in an accident each year. Suppose that the auto insurance by the household is considered fair. The household is trying to decide how much auto insurance (K) to buy. (d) Find the optimal level of insurance. (e) Suppose that the insurance is not fair, so that y = 0.4. Show that the household will consume less in the accident state than in the now accident state.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

1.
Purchasing Insurance: Suppose that the household has the utility function u(c) = log(c). The
household also possess wealth m = $1000 and in the event of an auto accident, the household will face a loss of
L = $400. Additionally, the household believes that there is a 25% chance that they will be in an accident each
year. Suppose that the auto insurance by the household is considered fair. The household is trying to decide how
much auto insurance (K) to buy.
(d) Find the optimal level of insurance.
(e) Suppose that the insurance is not fair, so that y = 0.4. Show that the household will consume less in the
accident state than in the now accident state.

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There is a bar on Off‐Main Street called the Rock‐n‐Roll Bar. All the people that go to that bar like to listen to rock‐n‐roll music, and they love live bands. If the bar owner brings bands in to play music on a Saturday night, she will make a lot of money. However there are tenants in this building who get annoyed by the loud music. The benefits/costs to the owner/tenants of having zero, one, two or three bands on a Saturday night are listed below. Assume the bar owner has the right to hire as many bands as she likes. Iftransaction costs were $90, split between the bar owner and the tenants, how manybands would play? What would social welfare be? A. Three bands would play and social welfare would be ‐100.B. Two bands would play and social welfare would be 75.C. Two bands would play and social welfare would be ‐15.D. No bands would play and social welfare would be 0.E. Three bands would play and social welfare would be ‐190
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