Farmer Brown faces a 25% chance of there being a year with prolonged drought, with zero yields and zero profit, and he faces a 75% chance of a normal year, with good yields and $100,000 profit. These probabilities are well-known. Suppose that an insurance company offered a drought insurance policy that pays the farmer $100,000 if a prolonged drought occurs. Assume that the farmer’s utility function is u(c) = ln(c). He has initial wealth of $40,000. What is the economic intuition on why X > Y? Confine your answer to at most three sentences.

Farmer Brown faces a 25% chance of there being a year with prolonged drought, with zero yields and zero profit, and he faces a 75% chance of a normal year, with good yields and $100,000 profit. These probabilities are well-known. Suppose that an insurance company offered a drought insurance policy that pays the farmer $100,000 if a prolonged drought occurs. Assume that the farmer’s utility function is u(c) = ln(c). He has initial wealth of $40,000. What is the economic intuition on why X > Y? Confine your answer to at most three sentences.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.3P

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