part A B C 1. Assume you have £300,000 worth of assets (W). This includes savings,property and your car. You use the car to drive to school/university everyday and there is a 1 in 20 (or 5 per cent) chance per year that you will beinvolved in an accident that results in the car being a write-off. Assume itsmarket value is £40,000 and remains the same i.e. it does not depreciate.You can take out a full insurance policy for the year that pays out the full£40,000 market value of the car if you have the accident. Assume theinsurance company has many customers with exactly the same assets asyou and who all face the same risk of being involved in a similar accident.a. What is the expected value of taking the gamble i.e. not buying theinsurance policy?b. Assume your utility function is W0.25 What is your expected utilityfrom taking the gamble?c. Calculate the certainty equivalent and risk premium of the gamble.d. What is the maximum amount you would be willing to pay for theinsurance policy out of your £300,000 worth of assets?e. What is the break-even/actuarially fair insurance premium in thiscase?f. Draw a diagram to illustrate your answers to the previousquestions. g. Assume the administration costs for the insurance company are£10 per customer. Explain how mutually beneficial trade is possibleover a range of prices. Calculate the individual consumer andproducer surplus at one particular price.Assume now that there are two types of driver. One half of them arevery skilful drivers and each of these has only a 2 per cent chanceper year of being involved in a car accident while the other half areless able/careful drivers who each have a 8 per cent chance per yearof being involved in an accident.h. Assume there is perfect information in the market. Calculate aninsurance premium for both the very skilful and less careful driversthat would enable mutually beneficial trade with the insurancecompany. Assume the administrative costs are still £10 per policyfor both types of customer.i. Assume now that there is asymmetric information in the market.When a customer purchases a policy, the insurance company doesnot know if they are skilful or less able drivers. What is the break-even/actuarially fair insurance premium if the insurance companyassumes that 50 per cent of its customers are the skilful driversand 50 per cent are the less able drivers? Assuming theadministration costs are still £10 per customers, what premiummight the insurance company charge on this basis?j. Using your answers to parts h. and i, predict what you think willhappen in the market at the premium you suggested in theprevious answer. Explain how this illustrates the process ofadverse selection. Calculate any lost surplus per customer.

Asset (W) = $300,000 Probability of accident of the car = 5% or 0.05 Market value of car = $40,000

1. Assume you have £300,000 worth of assets (W). This includes savings, property and your car. You use the car to drive to school/university every day and there is a 1 in 20 (or 5 per cent) chance per year that you will be involved in an accident that results in the car being a write-off. Assume its market value is £40,000 and remains the same i.e. it does not depreciate. You can take out a full insurance policy for the year that pays out the full £40,000 market value of the car if you have the accident. Assume the insurance company has many customers with exactly the same assets as you and who all face the same risk of being involved in a similar accident. a. What is the expected value of taking the gamble i.e. not buying the insurance policy? b. Assume your utility function is W0.25, What is your expected utility from taking the gamble? c. Calculate the certainty equivalent and risk premium of the gamble.

1. Assume you have £300,000 worth of assets (W). This includes savings, property and your car. You use the car to drive to school/university every day and there is a 1 in 20 (or 5 per cent) chance per year that you will be involved in an accident that results in the car being a write-off. Assume its market value is £40,000 and remains the same i.e. it does not depreciate. You can take out a full insurance policy for the year that pays out the full £40,000 market value of the car if you have the accident. Assume the insurance company has many customers with exactly the same assets as you and who all face the same risk of being involved in a similar accident. a. What is the expected value of taking the gamble i.e. not buying the insurance policy? b. Assume your utility function is W0.25, What is your expected utility from taking the gamble? c. Calculate the certainty equivalent and risk premium of the gamble.

Managerial Economics: Applications, Strategies and Tactics (MindTap Course List)

14th Edition

ISBN:9781305506381

Author:James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris

Publisher:James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris

Chapter13: best-practice Tactics: Game Theory

Section: Chapter Questions

Problem 14E

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