Question
There are two possible outcomes, Outcomes A and B. Suppose that Mr Morrison considers whether he should buy an insurance and the insurance premium is
There are two possible outcomes, Outcomes A and B. Suppose that Mr Morrison considers whether he should buy an insurance and the insurance premium is $10.00. Suppose that Mr Morrisons payoffs, exclusive of the insurance premium p, are given as follows:
Gain | Insurance Payment | |
Outcome A | $20 | $0 |
Outcome B | - $6 | $16 |
a. (1 marks) Suppose Mr Morrison buys the insurance. When Outcome A happens, what is his payoff?
b. (1 marks) Suppose Mr Morrison buys the insurance. When Outcome B happens, what is his payoff?
For the following questions, suppose that both outcomes are equally likely (meaning that each outcome arises with 50% chance).
c. (1 marks) What is Mr Morrisons expected payoff?
d. (4 marks) Suppose that Mr Morrisons utility function is u(w) = 2w - (1/100)*(w^2), where w is his monetary outcome. Calculate Mr Morrisons expected utility with and without the insurance.
e. (2 marks) Should Mr Morrison buy the insurance? Why or why not?
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