Question

In: Economics

Your income is $4900 and your utility is equal to the square root of your income....

Your income is $4900 and your utility is equal to the square root of your income. You have a 20% chance of getting sick; if you do, you incur $2400 in medical costs. There is no insurance in this example.

What is your expected utility?

sqrt(4900)*.8 + sqrt(2500)*.2 = 66

sqrt(4900*.8 + 2500*.2) = 66.48

sqrt(2500) = 50

sqrt(4900) = 70

Use the income, utility, income loss due to sickness, and probability of sickness from the above example. Now consider the effect of insurance. You can get full insurance, which would completely cover the cost of sickness, for a premium of $500. What would be your expected utility if you purchased insurance?

sqrt(4900+500) = 73.49

sqrt(4900-500)*.8 + sqrt(2500-500)*.2 = 62.01

sqrt(4900-500)*.2 + sqrt(2500-500)*.8 = 49.04

sqrt(4900-500) = 66.33

What would be your expected income, if your purchased full insurance in the above example?

5400

3600

4640

4400

Solutions

Expert Solution

Rahul Sunny answered 1 year ago
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