onsider an individual who faces two possible states of the world. With 20 percent probability he will face a bad state of the world, in which he must pay out $100 in health care expenses, and in the good state of the world he has no health care expenses. In either state of the world he earns income of $100 and consumes his income less his health care expenses. He is offered an opportunity to pay $20 up front (thereby reducing his consumption by $20 in either state of the world) for a health insurance contract that promises to pay him $100 to cover health care expenses in the bad state of the world. He seeks to maximize expected utility, where the utility he would derive in any state of the world is given by C0.5, where C is his consumption in that state of the world. a. Calculate the expected value of his consumption, first assuming that he does not purchase insurance and then assuming that he does. b. Calculate his expected utility, first assuming that h
Consider an individual who faces two possible states of the world. With 20 percent probability he will face a bad state of the world, in which he must pay out $100 in health care expenses, and in the good state of the world he has no health care expenses. In either state of the world he earns income of $100 and consumes his income less his health care expenses. He is offered an opportunity to pay $20 up front (thereby reducing his consumption by $20 in either state of the world) for a health insurance contract that promises to pay him $100 to cover health care expenses in the bad state of the world. He seeks to maximize expected utility, where the utility he would derive in any state of the world is given by C0.5, where C is his consumption in that state of the world.
a. Calculate the expected value of his consumption, first assuming that he does not purchase insurance and then assuming that he does.
b. Calculate his expected utility, first assuming that he does not purchase insurance and then assuming that he does. Would he choose to purchase the insurance?
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
