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Q3. Suppose that consumers have utility function U(C) = log(C) where C is the con- sumption level and log is the natural logarithm. Consumers have

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Q3. Suppose that consumers have utility function U(C) = log(C) where C is the con- sumption level and log is the natural logarithm. Consumers have initial consumption levels of 100 and are exposed to the following risk of loss: lose 10 with probability 0.4 and lose 5 with probability 0.6. They are considering buying insurance to cover these losses. (a) What is the fair price for the insurance? [2 marks] (b) What is the certainty equivalent level of C when uninsured? (Hint: Find the consumption level CE such that U(CE) equals the expected utility when uninsured.) [5 marks] (c) What is the maximum amount consumers are willing to pay for the insurance? [3 marks]

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