Microeconomics (2nd Edition) (Pearson Series in Economics)
2nd Edition
ISBN: 9780134492049
Author: Daron Acemoglu, David Laibson, John List
Publisher: PEARSON
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Question
Chapter 15, Problem 10P
(a)
To determine
Expected value of wealth.
(b)
To determine
Whether the insurance policy offered by the company is fair.
(c)
To determine
Whether an individual will purchase an insurance policy and act as a risk-averse.
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Students have asked these similar questions
As an investor, how do you diversify against risk?
You have $1,000 that you can invest. If you buy Ford stock, you face the following returns and probabilities from holding the stock for one year: with a probability of 0.2 you will get $1,500; with a probability of 0.4 you will get $1,100; and with a probability of 0.4 you will get $900. If you put the money into the bank, in one year’s time you will get $1,100 for certain.
a) What is the expected value of your earnings from investing in Ford stock?
b) Suppose you are risk-averse. Can we say for sure whether you will invest in Ford stock or put your money into the bank?
John owns and runs a food truck, which he expects to increase his wealth to $40,000 this year. John knows that every year, there
is a 20% chance that his truck will be firebombed by one of his ruthless food truck competitors. If this happens, he will face a bill
of $10,000 in repairs and lost income. John can choose to get insurance to cover all repair costs and lost wealth. Use this
information and the information in the table and graph to answer the questions.
Total utility
Wealth
Total utility (utils)
730
1000
$32,000
900
$34,000
755
800
700
$36,000
785
600
792
500
$38,000
400
300
200
100
0
$5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000
Wealth
What is John's expected wealth?
expected wealth: $
What is the price for John's insurance?
price of insurance: $
What is John's expected utility without insurance?
expected utility: 730
If John chooses to pay the insurance policy price, what would
be his total utility?
total utility:
1030
42000
10000
utils
utils
Chapter 15 Solutions
Microeconomics (2nd Edition) (Pearson Series in Economics)
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Similar questions
- You are deciding whether to buy a bond. The bond will pay out $1,000 in 5 years. But there is uncertainty over the interest rate. Between now and year 1 (period 0 and period 1), uncertainty will be resolved immediately after time 0. There is • 50 percent chance r = 0.1 • 50 percent chance r = 0.05 Interest compounds annually. What is the expected value of the bond? Economic subjectarrow_forward4) You are a financial professional working in a corporate loan department. A company named Mitch Hedberg Inc. (MH) comes to you for a loan. MH has debt from a previous loan (given by a different firm than yours) of 200. Your company analysts say that MH is likely to earn either 180, 240, or 300 this year - each with a probability of 1/3. MH wants you to lend them 100. MH could use this borrowed 100 to do either project X or project Y. Project X has a guaranteed return of 125 if the 100 is put there. Project Y may return either 0 or 210; each has probability of 1/2 and also costs 100 to do. a) Which project, X or Y, has the larger expected value? b) If you lend MH the 100, what will they do with the money? Why? Show your math. c) Should you lend MH the money or not? Show your math. d) Why did I choose the letters "MH" for this problem? What financial economic concept with initials "MH" is important in this problem?arrow_forwardWhat is the relationship between risk and return? What is the significance of this relationship for the investor?arrow_forward
- You expect to receive $10,000 at graduation in two years. You plan on investing it at 9 percent until you have $60,000. How long will you wait from now?arrow_forwardAt what point in one’s life is it safest to try a risky investment? Closer to or further from retirement?arrow_forwardWhat does it mean to be Risk Averse?arrow_forward
- 11. Case study a. Let's say your friend offer simple investment. You are planning to buy an asset for RM 3350. This investment is very safe. You would sell off the asset in three years for RM 400. You know you could invest RM 335 elsewhere at 10 percent with very little risk. What do you think of the proposed investment?arrow_forwardWhat advantage do you have if you begin investing for retirement at a young age? There is no advantage to starting to invest for retirement at a young age, a long time to take advantage of the time value of money, a guaranteed investment portfolio, a short time to take advantage of the time value of moneyarrow_forwardExplain what is the risk premium?arrow_forward
- After graduation, you face a choice. You can work for a multinational consulting firm and earn a starting salary (including benefits) of $40,000, or you can start your own consulting firm using $5,000 of your own savings. If you keep your money in a savings account, you can earn an interest rate of 7 percent. You choose to start your own consulting firm. At the end of the first year, you add up all of your expenses and revenues. Your expenses include $14,000 for rent, $1,000 for office supplies, $24,000 for labor, and $4,500 for telephone expenses. After operating your consulting firm for a year, your total revenues are $88,000. Instructions: Enter your answers as a whole number. a. What is your accounting profit? $ b. What is your economic profit? $ %24arrow_forwardDennis is planning to invest his money to earn more. He is willing to take a little risk by buying incomeearning assets to help him earn more. However, he wanted to make sure that when he needs the money he invested, he will be able to get part of it immediately. What type of investment would you advise Dennis to buy? Why?arrow_forwardAt what point in one’s life is it safest to try a risky investment? Closer to or further from retirement? Explain your logic.arrow_forward
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