A risk averse individual faces uncertainty with two outcomes: good, bad. The individual has income $1260 at good and $840 at bad outcome. The probability of good outcome is 5/7 (so the probability of bad outcome is 1 – 5/7 = 2/7). The individual can buy any nonnegative x units of insurance. Every unit of insurance has price $p and it pays $1 in the event of bad outcome. In this insurance market, the unit price of insurance is known to be p = 2/3.
A risk averse individual faces uncertainty with two outcomes: good, bad. The
individual has income $1260 at good and $840 at bad outcome. The probability of good outcome is 5/7 (so the probability of bad outcome is 1 – 5/7 = 2/7). The individual can buy any nonnegative x units of insurance. Every unit of insurance has price $p and it pays $1 in the
(a)Suppose the individual buys x units of insurance. Determine the individual's net income under good income, net income under bad income and the average net income. Draw these three in a diagram as
(b) For the individual: (i) compare full insurance with over insurance and (ii) compare full insurance with partial insurance. Then determine best choice of insurance for the individual.
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