The question is based on 'Uncertainity'. The question is a little unusual and difficult. I have attached the image. It is a multiple choice question; only one of the four options is correct. Please walk me through the logic of solving it. Thank you. 27. Mr. X has an exogenous income W and his utility from consumption cis u(c). Mr. X knows that an accident can occur with probability p andif it occurs, the monetary equivalent to the damage is T. Mr. X canhowever affect the accident probability p through the prevention efforte. In particular, e can take two values - zero and a and an assumptionis that p(0) > p(a), that is by putting prevention effort, probability ofoccurring an accident can be reduced. Let us also assume that if Mr.X puts an effört e, the disutility from the effort is Ae? where A is theper unit effort cost. What is the critical value of A, A*, below whichthe effort will be undertaken, and above which the effort will not beundertaken, by Mr. X ?(а) А*.[p(a)-p(0)][u(W-T)-u(W)]a2(b) А*p(@)-p(0)]a²Tu(W-T)-u(W)Ip(a) 4p(0)(W-T)a2(W)(c) A*(d) A*p(a)p(0)a²(W-T)u(W)||

We are going to solve this question using expectation approach.

Answered: 27. Mr. X has an exogenous income W and…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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The question is based on 'Uncertainity'. The question is a little unusual and difficult. I have attached the image. It is a multiple choice question; only one of the four options is correct. Please walk me through the logic of solving it. Thank you.

27. Mr. X has an exogenous income W and his utility from consumption c
is u(c). Mr. X knows that an accident can occur with probability p and
if it occurs, the monetary equivalent to the damage is T. Mr. X can
however affect the accident probability p through the prevention effort
e. In particular, e can take two values - zero and a and an assumption
is that p(0) > p(a), that is by putting prevention effort, probability of
occurring an accident can be reduced. Let us also assume that if Mr.
X puts an effört e, the disutility from the effort is Ae? where A is the
per unit effort cost. What is the critical value of A, A*, below which
the effort will be undertaken, and above which the effort will not be
undertaken, by Mr. X ?
(а) А*.
[p(a)-p(0)][u(W-T)-u(W)]
a2
(b) А*
p(@)-p(0)]a²
Tu(W-T)-u(W)I
p(a) 4
p(0)
(W-T)a2
(W)
(c) A*
(d) A*
p(a)p(0)a²
(W-T)u(W)
||

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