In: Economics
Skydiving – jumping out of an airplane with a parachute – is incredibly fun, but also dangerous. The risk of dying in a skydiving accident is actually very small – for this problem, we will assume it is zero. However, there is a substantial risk of other injuries.
There are standard precautions a skydive operator can take – such as using more modern equipment, hiring experienced instructors, and taking extra care in packing the parachutes – to reduce this risk. The cost of running a skydiving business is $150 per customer without these precautions; these precautions cost an additional $100 per customer and reduce the probability of injury from 1 in 100 to 1 in 300. The average skydiving injury does $30,000 worth of harm to the customer.
There are five potential customers, each with one opportunity to skydive; the joy each one would get from skydiving is worth $500, $400, $300, $200, and $100, respectively. (That is, the most enthusiastic customer would get a benefit of $500, the second-most-enthusiastic $400, and so on.)
Suppose there is perfect competitionin the skydiving industry – there are many skydive operators, with identical costs, so the price of skydiving is driven down to marginal cost plus expected liability payments (if any).
For parts (c)-(f), assume that customers correctly perceiveand consider the risk of injury when deciding whether to skydive, and can observe the level of precaution taken by each skydive operator.
For parts (g)-(j), assume instead that customers are unaware of the risk of injury, and completely ignore it when deciding whether or not to skydive – they simply weigh the financial price against the benefit. Continue to assume the skydiving industry is perfectly competitive.