Chapter 20, Problem 14P

To determine

To determine: The cost of a fair insure policy and if following people will take the insurances in the given situations.

Concept introduction

Expected Value: It is defined as the weighted average of probable events where the weights of each probable value corresponds to the chances of that value occurring. The formula to calculate expected value is:

Where,

• is expected value.
  
• is probability of event 1.
  
• is probability of event 2.
  
• is probability of event N.
  
• is event 1.
  
• is event 2.
  
• is event N.
  

Expected Utility It is defined as the value of a person’s total utility, so that there is no certainty for future results.

Fair Insurance Policy: It is an insurance policy in which the money offered by the company is equal to the expected value.

Risk Neutral: Any person who does not care for any kind of risk is known as risk neutral.

Moral Hazard: It is a situation of imperfect knowledge which leads to market failure. Example: A person who is insured against something does not bother about that thing.