3. Sarah's current disposable income is £90,000. Suppose there's a 1% chance that Sarah's house may be flooded, and if it is, the cost of repairing it will be £80,000, reducing her disposable income to £10,000. Suppose also that her utility function of income M is: U = √M (a) Calculate Sarah's expected income and expected utility given the risk of flooding. (b) For her to take an insurance that fully insures her in the event of house flooding, Sarah would have to pay a price for such an insurance, which would reduce her disposable income. What would be the minimum certain disposable income required for Sarah to take an insurance that fully insures her in the event of house flooding? Explain your answer. (c) Based on your answer to part b), what is the highest price Sarah would be willing to pay for an insurance policy that fully insures her in the event of house flooding? Explain your answer. (d )What is Sarah's attitude toward risk? Explain your answer. (e) Calculate the risk premium in this example. Based on your answer to part(d), interpret the concept of risk premium in this example.
3. Sarah's current disposable income is £90,000. Suppose there's a 1% chance that Sarah's house may be flooded, and if it is, the cost of repairing it will be £80,000, reducing her disposable income to £10,000. Suppose also that her utility function of income M is: U = √M (a) Calculate Sarah's expected income and expected utility given the risk of flooding. (b) For her to take an insurance that fully insures her in the event of house flooding, Sarah would have to pay a price for such an insurance, which would reduce her disposable income. What would be the minimum certain disposable income required for Sarah to take an insurance that fully insures her in the event of house flooding? Explain your answer. (c) Based on your answer to part b), what is the highest price Sarah would be willing to pay for an insurance policy that fully insures her in the event of house flooding? Explain your answer. (d )What is Sarah's attitude toward risk? Explain your answer. (e) Calculate the risk premium in this example. Based on your answer to part(d), interpret the concept of risk premium in this example.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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please answer the below microeconomics questions, thanks
Transcribed Image Text:3. Sarah's current disposable income is £90,000. Suppose there's a 1% chance
that Sarah's house may be flooded, and if it is, the cost of repairing it will be
£80,000, reducing her disposable income to £10,000. Suppose also that her
utility function of income M is: U = VM
(a) Calculate Sarah's expected income and expected utility given the risk of
flooding.
%3D
(b) For her to take an insurance that fully insures her in the event of house
flooding, Sarah would have to pay a price for such an insurance, which would
reduce her disposable income. What would be the minimum certain
disposable income required for Sarah to take an insurance that fully insures
her in the event of house flooding? Explain your answer.
(c) Based on your answer to part b), what is the highest price Sarah would be
willing to pay for an insurance policy that fully insures her in the event of
house flooding? Explain your answer.
(d )What is Sarah's attitude toward risk? Explain your answer.
(e) Calculate the risk premium in this example. Based on your answer to
part(d), interpret the concept of risk premium in this example.
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