A risk averse individual faces a risk. The individual's utility function is U(W)= In(W) where W is the wealth of the individual. The individual has an initial amount of wealth of 1000$. 20% of the time, the individual will lose 200$. The other 80% of the time, his wealth remains at its initial level. a) An insurer offers a premium of 50$ to the individual. Should the risk averse individual accept the deal? b) Now suppose that the risk averse individual has an initial wealth of 400$ instead of 1000$. The premium is still 50$. Should he accept the deal? c) Would a risk neutral individual accept a premium of 50$? Show why or why not by calculating the expected utility of the risk neutral individual.

A risk averse individual faces a risk. The individual's utility function is U(W)= In(W) where W is the wealth of the individual. The individual has an initial amount of wealth of 1000$. 20% of the time, the individual will lose 200$. The other 80% of the time, his wealth remains at its initial level. a) An insurer offers a premium of 50$ to the individual. Should the risk averse individual accept the deal? b) Now suppose that the risk averse individual has an initial wealth of 400$ instead of 1000$. The premium is still 50$. Should he accept the deal? c) Would a risk neutral individual accept a premium of 50$? Show why or why not by calculating the expected utility of the risk neutral individual.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter16: Labor Markets

Section: Chapter Questions

Problem 16.9P

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