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QUESTION 7 A consumer has the following indirect utility function: v(p,m)= PiP2 Suppose he faces income risk, whereby his income may fall from m = 6300 to m 300 with probability 0.25. (a) Calculate the risk premium associated with this prospect when p₁ = p₁ =1. Would your answer be different if you chose different prices? Explain. (b) Suppose this consumer can purchase insurance against this income loss at price r = 0.5 per dollar of coverage. How much insurance coverage will he buy when P₁ = P₁ = 1? Is the price of insurance actuarially fair? Explain.

QUESTION 7 A consumer has the following indirect utility function: v(p,m)= PiP2 Suppose he faces income risk, whereby his income may fall from m = 6300 to m 300 with probability 0.25. (a) Calculate the risk premium associated with this prospect when p₁ = p₁ =1. Would your answer be different if you chose different prices? Explain. (b) Suppose this consumer can purchase insurance against this income loss at price r = 0.5 per dollar of coverage. How much insurance coverage will he buy when P₁ = P₁ = 1? Is the price of insurance actuarially fair? Explain.

Understanding Business
Understanding Business
12th Edition
ISBN:9781259929434
Author:William Nickels
Publisher:William Nickels
Chapter1: Taking Risks And Making Profits Within The Dynamic Business Environment
Section: Chapter Questions
Problem 1CE
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QUESTION 7 A consumer has the following indirect utility function: v(p,m)= PiP2 Suppose he faces income risk, whereby his income may fall from m = 6300 to m 300 with probability 0.25. (a) Calculate the risk premium associated with this prospect when p₁ = p₁ =1. Would your answer be different if you chose different prices? Explain. (b) Suppose this consumer can purchase insurance against this income loss at price r = 0.5 per dollar of coverage. How much insurance coverage will he buy when P₁ = P₁ = 1? Is the price of insurance actuarially fair? Explain.
Transcribed Image Text:QUESTION 7 A consumer has the following indirect utility function: v(p,m)= PiP2 Suppose he faces income risk, whereby his income may fall from m = 6300 to m 300 with probability 0.25. (a) Calculate the risk premium associated with this prospect when p₁ = p₁ =1. Would your answer be different if you chose different prices? Explain. (b) Suppose this consumer can purchase insurance against this income loss at price r = 0.5 per dollar of coverage. How much insurance coverage will he buy when P₁ = P₁ = 1? Is the price of insurance actuarially fair? Explain.
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