Suppose an individual earns income $600 when they are sick, and $1000 when they are healthy. Suppose this individual is sick with probability p = 0.5 and has a utility function over income, I, of U(I) = ln(I).
- Is this individual risk-averse, risk neutral or risk-loving?
- Suppose she is able to purchase insurance at any amount from at an actuarially fair price. Fully describe the amount she would purchase (payout, premium and final outcomes).
- Verify that she is better off with the contract in part b, as opposed to being uninsured.
- Suppose insurance company A offers a payout q = $400 (when she is sick) at a premium of r = $220 and insurance company B offers a payout of $200 at a premium of $100.
- Company A's contract is: Actuarially fair or unfair? Is it full or partial insurance?
- Company B's contract is: Actuarially fair or unfair? Is it full or partial insurance?
Which contract does this individual prefer?
Suppose contract A is unfair, but offers full coverage at price . Contract B is fair but only offers partial coverage at. The probability of being sick is . Derive a general expression for as a function of and the other parameters, such that our individual would be indifferent between the two contracts.
Hint: Just write down the system of equations, you do not need to solve for closed-form solutions.
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can you please explain step 4 again, I can't see whats written there.
can you please explain step 4 again, I can't see whats written there.
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