see attached Exercise 4: InsuranceFiona has von Neumann-Morgenstern utility function u(x) =VT and initial wealth 640, 000. She faces a25% chance of losing L = 280, 000.1. Is Fiona risk averse?2. What is Fiona's utility if no loss occurs, what is her utility if the loss occurs? What is Fiona's expectedutility?3. What is the cost of fair insurance against the possible loss?Suppose Fiona is able to choose insurance with any coverage z E [0, 1] (i.e. 0 < z < 1). If she buys insurancecoverage at level z, she will get reimbursed z · 280, 000 if the loss occurs. Insurance coverage at level z costsco + z· C1ifz > 0C(z) =0 ifz = 04. Suppose co = 0 and c1 = 70, 000. Is insurance at coverage level z > 0 fair insurance? What coveragelevel z* would Fiona choose? Explain.5. Suppose co = 100 and ci = 70, 000. Is insurance at coverage level z > 0 fair insurance? What coveragelevel z** would Fiona choose? Explain. (Note that co = 100 is an "avoidable fixed cost" which is onlypaid if she chooses strictly positive insurance coverage. However, the "marginal cost" of additionalinsurance, c1 = 70, 000, is the same as in the previous part.)6. Suppose co = 100 and c1 = 72,000. Is full insurance, that is, coverage level z = 1 optimal? Explain.

Fiona has von Neumann-Morgenstern utility function u(x) = VT and initial wealth 640, 000. She faces a 25% chance of losing L = 280, 000. 1. Is Fiona risk averse? 2. What is Fiona's utility if no loss occurs, what is her utility if the loss occurs? What is Fiona's expected utility? 3. What is the cost of fair insurance against the possible loss?

Fiona has von Neumann-Morgenstern utility function u(x) = VT and initial wealth 640, 000. She faces a 25% chance of losing L = 280, 000. 1. Is Fiona risk averse? 2. What is Fiona's utility if no loss occurs, what is her utility if the loss occurs? What is Fiona's expected utility? 3. What is the cost of fair insurance against the possible loss?

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.4P

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