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
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