Chapter7: Uncertainty
Section: Chapter Questions
Problem 7.1P
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A has a utility of money function given by U(y) = y.
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All of A's wealth is in his land and his house; the total value is $1,000,000. With probability 0.4, the house will burn down within the year, and A's remaining wealth will be only the value of the land, which is $28,900. Using at least half page for your diagram, sketch A's indifference curve given the situation above. Put income in the bad state (loss occurs) on the horizontal axis. Identify the following in your diagram:
a. the expected value of the gamble Jackson faces
b, A's certainty equivalent of the gamble
c. the amount Jackson would be charged for actuarially fair full insurance.
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