Question

In: Economics

a)What is the maximum amount he would be willing to pay for an insurance above the expected loss?


If Lesley has $100 and 10% probability of losing $30.His utility of having $100 is 10,his utility of having $70 is 8,and his utility of having $97 is 9.8. Please, answer and graph:

a)What is the maximum amount he would be willing to pay for an insurance above the expected loss?

Solutions

Expert Solution

Probability of Loss = 10%

Probability of no loss = 90%

Total wealth = $100

Utility of total wealth = 10

Utility of total wealth after loss = 8

Expected utility = Utility of total wealth * Probability of no loss + Utility of Total wealth after loss * Probability of Loss

= (10 * 90%) + ( 8 * 10% )

= 9.8

Total wealth required at the expected utility of 9.8 is $97 ( Given )

Hence the maximum amount of risk premium which Lesley can give is ( $100 - $97 ) = $3

Rahul Sunny answered 2 years ago
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