Answer all questions.Imagine you are a person with a chronic disease. If the disease flares up, you will have to take substantial leave from work. The probability of the flare-up is 0.2 (or 20%). If you do not need to take leave from work, your income is $6400. If you take leave from work, your income is $1600. What is the expected value of your income?Expected utility E [= (U(1)] = pU (IS) + (1-p) U (IH)1600 x 0.2 + 0.8 x 6400 = 5540Assume that your utility function . What is the expected utility of your income?0.8 √ 6400 + 0.2 √1600 = 72 utilsSuppose a company is offering insurance where your premium is $500 and your payout is $2000.What is your expected utility from taking on this insurance? (Hint: you need to calculate your adjusted earnings in both states)

We are going to get the payout with probability 0.2 but we have to pay premium in both the states.

Answered: Suppose a company is offering insurance…

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.1P

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Answer all questions.

Imagine you are a person with a chronic disease. If the disease flares up, you will have to take substantial leave from work. The probability of the flare-up is 0.2 (or 20%). If you do not need to take leave from work, your income is $6400. If you take leave from work, your income is $1600.

What is the expected value of your income?

Expected utility E [= (U(1)] = pU (IS) + (1-p) U (IH)

1600 x 0.2 + 0.8 x 6400 = 5540

Assume that your utility function . What is the expected utility of your income?

0.8 √ 6400 + 0.2 √1600 = 72 utils

Suppose a company is offering insurance where your premium is $500 and your payout is $2000.

What is your expected utility from taking on this insurance? (Hint: you need to calculate your adjusted earnings in both states)

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