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This question pertains to how individuals deal with risky situations and interact with others in similar situations to mitigate risk. Suppose you invest in a
This question pertains to how individuals deal with risky situations and interact with others in similar situations to mitigate risk.
Suppose you invest in a business with risky returns:
- With probability 0.6 you have good luck and earn $144,000
- With probability 0.4 you have bad luck and earn $64,000.
Suppose your friend has a sure income of $144,000. She offers to provide you with an insurance contract:
- If you have good luck you pay her $x
- If you have bad luck she makes you a payment so that your income is $100,000
Both of you have Utility from income: U(I) = I
- What is the minimum value of x (to the nearest dollar) such that your friend will provide you with insurance? (Hint: think about your friends expected utility.)
- What is the maximum value of x (to the nearest dollar) for which you will accept your friends offer? (Hint: think about your expected utility.)
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