Suppose an individual makes $50,000 of income per year. Her utility function is given by u=10x0.5, where x is her income minus expenses.

Suppose an individual makes $50,000 of income per year. Her utility function is given by u=10x^0.5, where x is her income minus expenses. She realizes that there is about a 5% probability that she may suffer a heart attach in any given year. The cost of treatment will be $40,000 if a heart attack occurs.

She has the option of buying health insurance for $2,000 per year, which will cover all expenses in case of a heart attack. Should she buy this health insurance?

(Note: x^0.5 is a different way of writing the square root of x)

	a.	Yes, she is risk averse and wants to avoid losses at all costs.
	b.	She is indifferent between buying insurance and not buying insurance, as her expected income is 48,000 for either option.
	c.	No, her expected utility without insurance is 985.36, which is higher than her expected utility with insurance.
	d.	Yes, her expected utility with insurance is higher by 16.63 than without insurance.
	e.	None of these options.

Expert Solution

orchestra answered 2 years ago

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