3. For all of the following questions, consider a situation with two states of the world in which state 1 has probability = 1/3 and state 2 therefore has probability 1 = 2/3. An individual is endowed with wealth of W = $40,000 in state 2, but faces a possible loss of L = $30,000 in state 1, bringing wealth down to $10,000. Insurance is available: it costs 50 cents up front for each $1 dollar of insurance paid out in state 1. (a) Is the insurance actuarially fair or actuarially unfair? (b) Give the formula for consumption in each state if insurance paying out $Y in state 1 is purchased.
3. For all of the following questions, consider a situation with two states of the world in which state 1 has probability = 1/3 and state 2 therefore has probability 1 = 2/3. An individual is endowed with wealth of W = $40,000 in state 2, but faces a possible loss of L = $30,000 in state 1, bringing wealth down to $10,000. Insurance is available: it costs 50 cents up front for each $1 dollar of insurance paid out in state 1. (a) Is the insurance actuarially fair or actuarially unfair? (b) Give the formula for consumption in each state if insurance paying out $Y in state 1 is purchased.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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