(a) (4 points) Briefly explain the relation between individuals' valuation for insurance,

the shape of their utility function, and their risk preferences.

(b) (8 points) Unemployment insurance systems typically pay out benefits with a re placement rate well below 100%. Typical replacement rates are around 60-70% comparing actual unemployment benefits to the earnings from last employment. Workers who become unemployed thus suffer a loss in disposable income compared to their income before the layoff. Discuss pros and cons of this common practice based on what you know about social insurance.