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(d) What is the maximum the agent will pay for insurance? Show your work. Note that insurance here is complete. (e) Assume instead that utility is U(x) = (x/1000)². Now what is the maximum the risk-loving agent will pay for insurance? Show your work. Compare to the maximum payment for the risk-averse agent and discuss.< (f) Why is the risk-loving agent willing to buy insurance if they love risk? Explain fully the intuition.<

(d) What is the maximum the agent will pay for insurance? Show your work. Note that insurance here is complete. (e) Assume instead that utility is U(x) = (x/1000)². Now what is the maximum the risk-loving agent will pay for insurance? Show your work. Compare to the maximum payment for the risk-averse agent and discuss.< (f) Why is the risk-loving agent willing to buy insurance if they love risk? Explain fully the intuition.<

Managerial Economics: A Problem Solving Approach
Managerial Economics: A Problem Solving Approach
5th Edition
ISBN:9781337106665
Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Chapter2: The One Lesson Of Business
Section: Chapter Questions
Problem 2.3IP
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Consider the following FIRE INSURANCE PROBLEM where fire partially destroys a $350,000 house.< EVENT FIRE NO FIRE PROBABILITY OUTCOME 50,000 350,000 0.01 0.99 INSURANCE PAYOUT< < < 300,000 0 € (a) What do we mean when we say an agent is Risk Averse? < (b) Assume utility is U(x) = √(x/1000). Why does this utility function imply the agent is risk-averse? Use a figure/diagram to explain. (c) What is the expected utility of having no insurance for this risk-averse agent? What is the certainty equivalent of no insurance? Show your work. (d) What is the maximum the agent will pay for insurance? Show your work. Note that insurance here is complete.< (e) Assume instead that utility is U(x) = (x/1000)². Now what is the maximum the risk-loving agent will pay for insurance? Show your work. Compare to the maximum payment for the risk-averse agent and discuss.< (f) Why is the risk-loving agent willing to buy insurance if they love risk? Explain fully the intuition.<
Transcribed Image Text:Consider the following FIRE INSURANCE PROBLEM where fire partially destroys a $350,000 house.< EVENT FIRE NO FIRE PROBABILITY OUTCOME 50,000 350,000 0.01 0.99 INSURANCE PAYOUT< < < 300,000 0 € (a) What do we mean when we say an agent is Risk Averse? < (b) Assume utility is U(x) = √(x/1000). Why does this utility function imply the agent is risk-averse? Use a figure/diagram to explain. (c) What is the expected utility of having no insurance for this risk-averse agent? What is the certainty equivalent of no insurance? Show your work. (d) What is the maximum the agent will pay for insurance? Show your work. Note that insurance here is complete.< (e) Assume instead that utility is U(x) = (x/1000)². Now what is the maximum the risk-loving agent will pay for insurance? Show your work. Compare to the maximum payment for the risk-averse agent and discuss.< (f) Why is the risk-loving agent willing to buy insurance if they love risk? Explain fully the intuition.<
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