When Shalini is sick, she values wealth according to the utility function US(w) = ln (w). When she is healthy, she values wealth according to UH(w) = 1.1 ln (w). Shalini allocates wealth of $1,000 for each week and has a 5% chance of getting sick. a) Would Shalini be willing to spend $30 of her of her $1,000 wealth in order to guarantee avoiding getting sick, if it were possible for her to do so? (b) Would Shalini be willing to spend $30 of her of her $1,000 wealth in order to buy an (actuarially fair) insurance policy under which she receives $600 in indemnity if she gets sick? (c) How do you explain your answers to parts a and b above? How do the answers compare and how you can intuitively explain them in this context?
When Shalini is sick, she values wealth according to the utility function US(w) = ln (w). When she is healthy, she values wealth according to UH(w) = 1.1 ln (w). Shalini allocates wealth of $1,000 for each week and has a 5% chance of getting sick.
a) Would Shalini be willing to spend $30 of her of her $1,000 wealth in order to guarantee avoiding getting sick, if it were possible for her to do so?
(b) Would Shalini be willing to spend $30 of her of her $1,000 wealth in order to buy an (actuarially fair) insurance policy under which she receives $600 in indemnity if she gets sick?
(c) How do you explain your answers to parts a and b above? How do the answers compare and how you can intuitively explain them in this context?
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