Farmer Brown faces a 25% chance of there being a year with prolonged drought, with zero yields and zero profit, and he faces a 75% chance of a normal year, with good yields and $100,000 profit. These probabilities are well-known. Suppose that an insurance company offered a drought insurance policy that pays the farmer $100,000 if a prolonged drought occurs. Assume that the farmer’s utility function is u(c) = ln(c). He has initial wealth of $40,000. What is the economic intuition on why X > Y? Confine your answer to at most three sentences.
Farmer Brown faces a 25% chance of there being a year with prolonged drought, with zero yields and zero profit, and he faces a 75% chance of a normal year, with good yields and $100,000 profit. These probabilities are well-known. Suppose that an insurance company offered a drought insurance policy that pays the farmer $100,000 if a prolonged drought occurs. Assume that the farmer’s utility function is u(c) = ln(c). He has initial wealth of $40,000. What is the economic intuition on why X > Y? Confine your answer to at most three sentences.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Farmer Brown faces a 25% chance of there being a year with prolonged
drought, with zero yields and zero profit, and he faces a 75% chance of a normal year, with good yields and
$100,000 profit. These probabilities are well-known. Suppose that an insurance company offered a drought
insurance policy that pays the farmer $100,000 if a prolonged drought occurs. Assume that the farmer’s
utility function is u(c) = ln(c). He has initial wealth of $40,000.
What is the economic intuition on why X > Y? Confine your answer to at most three sentences.
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