2 Scenario Your client, InsureCorp, is an insurance company considering launching an 'income insur- ance' product in the nation of Motherland. Income insurance is a product that fully insures a household against changes in income caused by a major injury or illness. At present, no businesses are selling income insurance products in Motherland. Initial market research suggests that there are 15,000 households in Motherland interested in purchasing income insurance. Your client expects that the fixed cost of launching the income insurance product will be $25,000,000 per year, and that each policy issued to a customer will cost the company an additional $2,000 in sales commissions. 2.1 Your task Your client wants you to analyse the potential market for income insurance and report on the following: • What is the maximum price the company can charge a household for an income insurance policy? What is the expected profit (or loss) for the company if it becomes a monopoly provider of income insurance? • Is there a risk that rival insurance companies will also enter the market, selling identical income insurance products? If so, what would be the expected profit of your client? (You should assume that any competitors would face the same costs as your client.)
2 Scenario Your client, InsureCorp, is an insurance company considering launching an 'income insur- ance' product in the nation of Motherland. Income insurance is a product that fully insures a household against changes in income caused by a major injury or illness. At present, no businesses are selling income insurance products in Motherland. Initial market research suggests that there are 15,000 households in Motherland interested in purchasing income insurance. Your client expects that the fixed cost of launching the income insurance product will be $25,000,000 per year, and that each policy issued to a customer will cost the company an additional $2,000 in sales commissions. 2.1 Your task Your client wants you to analyse the potential market for income insurance and report on the following: • What is the maximum price the company can charge a household for an income insurance policy? What is the expected profit (or loss) for the company if it becomes a monopoly provider of income insurance? • Is there a risk that rival insurance companies will also enter the market, selling identical income insurance products? If so, what would be the expected profit of your client? (You should assume that any competitors would face the same costs as your client.)
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:2 Scenario
Your client, InsureCorp, is an insurance company considering launching an 'income insur-
ance' product in the nation of Motherland. Income insurance is a product that fully insures
a household against changes in income caused by a major injury or illness.
At present, no businesses are selling income insurance products in Motherland. Initial
market research suggests that there are 15,000 households in Motherland interested in
purchasing income insurance.
Your client expects that the fixed cost of launching the income insurance product will
be $25,000,000 per year, and that each policy issued to a customer will cost the company
an additional $2,000 in sales commissions.
2.1 Your task
Your client wants you to analyse the potential market for income insurance and report on
the following:
What is the maximum price the company can charge a household for an income
insurance policy?
What is the expected profit (or loss) for the company if it becomes a monopoly
provider of income insurance?
Is there a risk that rival insurance companies will also enter the market, selling
identical income insurance products? If so, what would be the expected profit of
your client? (You should assume that any competitors would face the same costs as
your client.)
2.2 Household welfare
A typical household in Motherland has an income of $96,000 per year, which they spend
on food (good x) and clothing (good y). Their preferences over consumption baskets are
represented by the utility function,
The associate marginal utilities are,
U = x²/9¹/9
MUx =
2y¹/9
9x7/9
x2/9
9y8/9
and MUy
The price of food is Px = $8 per meal, and the price of clothing is Py = $4 per item.
Each household has a 40% probability of experiencing a major injury or illness in any
given year. If a household experiences a major injury or illness, its income will be reduced
to $40,500 per year.
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