A risk averse individual faces uncertainty with two outcomes: good, bad. The

individual has income $560 under good and $350 under bad outcome. The probability of good

outcome is 4/7 (so the probability of bad outcome is 1 4/7 = 3/7). The individual can buy any

non-negative x units of insurance. Every unit of insurance has price $p and it pays $1 in the event

of bad outcome. In this insurance market, the unit price of insurance is known to be p = 1/2.

(a) Determine if the insurance market is competitive or not.

(b) Suppose the individual buys x units of insurance. Determine the individual's net

income under good income, net income under bad income and the average net income. Draw

these three in a diagram as functions of x.

(c) For the individual: (i) compare full insurance with over insurance and (ii) compare

full insurance with partial insurance. Then determine best choice of insurance for the individual.

(d) Consider the same problem, but suppose the individual is risk neutral instead of

risk averse. Determine best choice of insurance for the individual.