Adam has wealth of $40,000 as long as his business does not burn down. However, there...

Adam has wealth of $40,000 as long as his business does not burn down. However, there is a 30% probability that his business will burn down, causing a loss of $30,000 and leaving him with $10,000 of wealth. Adam's utility function is given by U = W^0.5 where W is wealth. Suppose Adam purchases insurance to cover the potential $30,000 loss. If the insurance premium is actuarially fair, Adam's utility with insurance is:

Expert Solution

Solution:-

Actuarially fair premium (p) = probability of loss× loss in wealth

= 30% * 30000

= $9000

Utility with insurance = (W-p) ^ 0.5

= (40000 - 9000) ^0.5

= 31,0000.5

=176.09

Rahul Sunny answered 8 months ago

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