1) to avoid an accident at work or not exert any effort (eJohn is deciding whether to exert effort (e =0). If e = 1, the probability of an accident is 0.5. If e = 0, the probability of an accident is 1. John'sincome without the accident is $100. In case of an accident, medical expenses will be $64. John utility ofincome is VI. The cost of effort, C(e), is 0 if effort is e = 0 and 1 if effort is e = 1. John's utility functionis u(I, e) = Vī – C(e).(a) What are the expected utility values that John would face when he exerts effort and when hedoes not exert effort? Based on your calculations, should he exert effort? Briefly explain theintuition behind his decision in one or two sentences.Now suppose there is a risk neutral insurance company. Suppose the insurance company cannotmonitor whether John exerts effort or not. The insurance company considers two plan contracts.Contract Plan A:Premium: p = $36.Payout in the event of accident: d = $64Contract Plan B:Premium: p = $19.Payout in the event of accident: d = $32(b) For each plan contract, calculate John's final income in the event of no accident and in the eventof an accident occurs. It might be useful to list them in a table like this:Plan ContractIno accidentlaccidentAВWhich contract that provide consumption smoothing across two possible states of the world. Inother words, which contract provides the best overall insurance to John?(c) For each of these contracts, determine which of the two effort levels, e = 0 or e = 1, would beexpected utility maximizing for John if he decides to enroll in the plan contract. Assume that, ifboth effort levels yield the same expected utility, John will opt into effort level e = 1. Brieflyrelate your answer to the concept of moral hazard.

Given information Utility of money=I0.5 Total utility=I0.5-c(e) e=1 when exert effort at work and…

John is deciding whether to exert effort (e = 1) to avoid an accident at work or not exert any effort (e = 0). If e = 1, the probability of an accident is 0.5. If e = 0, the probability of an accident is 1. John's income without the accident is $100. In case of an accident, medical expenses will be $64. John utility of income is VI. The cost of effort, C(e), is 0 if effort is e = 0 and 1 if effort is e = 1. John's utility function is u(I, e) = Vī – C(e). (a) What are the expected utility values that John would face when he exerts effort and when he does not exert effort? Based on your calculations, should he exert effort? Briefly explain the intuition behind his decision in one or two sentences. Now suppose there is a risk neutral insurance company. Suppose the insurance company cannot monitor whether John exerts effort or not. The insurance company considers two plan contracts.

John is deciding whether to exert effort (e = 1) to avoid an accident at work or not exert any effort (e = 0). If e = 1, the probability of an accident is 0.5. If e = 0, the probability of an accident is 1. John's income without the accident is $100. In case of an accident, medical expenses will be $64. John utility of income is VI. The cost of effort, C(e), is 0 if effort is e = 0 and 1 if effort is e = 1. John's utility function is u(I, e) = Vī – C(e). (a) What are the expected utility values that John would face when he exerts effort and when he does not exert effort? Based on your calculations, should he exert effort? Briefly explain the intuition behind his decision in one or two sentences. Now suppose there is a risk neutral insurance company. Suppose the insurance company cannot monitor whether John exerts effort or not. The insurance company considers two plan contracts.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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1. Mr. Smith can cause an accident, which entails a monetary loss of $1000 to Ms. Adams. The likelihood of the accident depends on the precaution decisions by both individuals. Specifically, each individual can choose either "low" or "high" precaution, with the low precaution requiring no cost and the high precaution requiring the effort cost of $200 to the individual who chooses the high precaution. The following table describes the probability of an accident for each combination of the precaution choices by the two individuals. Adams chooses low precaution Adams chooses high precaution Smith chooses low precaution Smith chooses high precaution 0.8 0.5 0.7 0.1 1) What is the socially efficient outcome? For each of the following tort rules, (i) construct a table describing the individuals' payoffs under different precaution pairs and (ii) find the equilibrium precaution choices by the individuals. 2) a) No liability b) Strict liability (with full compensation) c) Negligence rule (with…