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A2: RISK and INSURANCE .20 points. Consider the following FIRE INSURANCE PROBLEM where fire partially destroys a $350,000 house. EVENT PROBABILITY OUTCOME INSURANCE PAYOU FIRE
A2: RISK and INSURANCE .20 points. Consider the following FIRE INSURANCE PROBLEM where fire partially destroys a $350,000 house. EVENT PROBABILITY OUTCOME INSURANCE PAYOU FIRE 0.01 50,000 300,000 N0 FIRE 0.99 350,000 0 (2 points) (a) What do we mean when we say an agent is RiskAverse? (3 points) (In) Assume utility is U(x) = v'(x!1000). Why does this utility function imply the agent is risk ayerse? Use a figure/diagram to explain. (2 points) ((2) What is the expected utiiftyof having no insurance for this risk~averse agent? What is the certainty equivaientof no insurance? Show your work. (3 points) (d) What is the maximum the agent will pay for insurance? Show your work. Note that insurance here is complete. (5 points) (e) Assume instead that utility is U(x) = (#1000)? Now what is the maximum the risk foving agent will pay for insurance? Show your work. Compare to the maximum payment for the riskrayerse agent and discuss. (5 points) (f) Why is the risk~loying agent willing to buy insurance if they love risk? Explain fully the intuition
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