1. In a model with uncertainty, there are two “states of the world”. In state on

Q: 1. In a model with uncertainty, there are two “states of the world”. In state on

a) Expected loss in case of accident = P(Accident) * amount lost = 0.05* 100,000 = $5,000. So consumer agree to pay anything less than $5,000 b) Yes, he will take ethe insurance as expected insuarance amount is 5,000 > 2,500 for the same amount of insurance.

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Question

1. In a model with uncertainty, there are two “states of the world”. In state one, the consumer has a yearly income of $100,000. In state two, the consumer gets hurt in an accident and cannot work, so he has no income. The probability of an accident is 5%.

a.How much will the consumer agree to pay for insurance that gives him $100,000 compensation in case he has an accident if he is risk neutral?

b.Now suppose the consumer is risk averse. He is offered an insurance that will pay him $100,000 in case of an accident. The insurance costs $2500. Will he buy the insurance? Why or why not?

Explanation / Answer

Expected loss in case of accident = P(Accident) * amount lost = 0.05* 100,000 = $5,000.

So consumer agree to pay anything less than $5,000

Yes, he will take ethe insurance as expected insuarance amount is 5,000 > 2,500 for the same amount of insurance.

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1. In a model with uncertainty, there are two “states of the world”. In state on

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1. In a model with uncertainty, there are two “states of the world”. In state on

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