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Consider the following FIRE INSURANCE PROBLEM where fire destroys a $100 000 house. FIRE + NO FIRE + PROBABILITY 0.05 0.95€ OUTCOME 0P 100 000 INSURANCE PAYOUT 100 000 0P a) What are the expected payoffs (E(x)) if the agent does not purchase insurance? b) Assume utility is (*)=√(x/1000). What is the expected payoff and utility of having no insurance? c) What is the maximum this person be willing to pay for full coverage insurance that pays $100 000 in case of fire? → d) Now suppose utility is U(*) = (x/1000)². What is the maximum the homeowner will pay for full coverage insurance now?

Consider the following FIRE INSURANCE PROBLEM where fire destroys a $100 000 house. FIRE + NO FIRE + PROBABILITY 0.05 0.95€ OUTCOME 0P 100 000 INSURANCE PAYOUT 100 000 0P a) What are the expected payoffs (E(x)) if the agent does not purchase insurance? b) Assume utility is (*)=√(x/1000). What is the expected payoff and utility of having no insurance? c) What is the maximum this person be willing to pay for full coverage insurance that pays $100 000 in case of fire? → d) Now suppose utility is U(*) = (x/1000)². What is the maximum the homeowner will pay for full coverage insurance now?

Microeconomic Theory
Microeconomic Theory
12th Edition
ISBN:9781337517942
Author:NICHOLSON
Publisher:NICHOLSON
Chapter7: Uncertainty
Section: Chapter Questions
Problem 7.8P
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Question
3 Consider the following FIRE INSURANCE PROBLEM where fire destroys a $100 000 house. FIRE → NO FIRE → PROBABILITY 0.05 0.95€ OUTCOME 0+ 100 000 INSURANCE PAYOUT 100 000 0+ a) What are the expected payoffs (E(x)) if the agent does not purchase insurance?+ b) Assume utility is U(*)=√(x/1000). What is the expected payoff and utility of having no insurance? c) What is the maximum this person be willing to pay for full coverage insurance that pays $100 000 in case of fire? → d) Now suppose utility is U(*) = (x/1000)². What is the maximum the homeowner will pay for full coverage insurance now? →
Transcribed Image Text:3 Consider the following FIRE INSURANCE PROBLEM where fire destroys a $100 000 house. FIRE → NO FIRE → PROBABILITY 0.05 0.95€ OUTCOME 0+ 100 000 INSURANCE PAYOUT 100 000 0+ a) What are the expected payoffs (E(x)) if the agent does not purchase insurance?+ b) Assume utility is U(*)=√(x/1000). What is the expected payoff and utility of having no insurance? c) What is the maximum this person be willing to pay for full coverage insurance that pays $100 000 in case of fire? → d) Now suppose utility is U(*) = (x/1000)². What is the maximum the homeowner will pay for full coverage insurance now? →
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