7.8 What mix of wheat and maize would provide maximum expected utility to this farmer?

Would wheat crop insurance – which is available to farmers who grow only wheat and which costs

€4000 and pays off €8000 in the event of a rainy growing season – cause this farmer to change what he plants?

In Equation 7.30 we showed that the amount an individual is willing to pay to avoid a fair gamble (h) is given by p = 0.5E

(h 2)r

(W

), where r (W ) is the measure of absolute risk aversion at this person’s initial level of wealth. In this problem we look at the size of this payment as a function of the size of the risk faced and this person’s level of wealth.

a.

Consider a fair gamble (ν) of winning or losing

€1. For this gamble, what is E

(ν2)?

b.

c.

d.