MyLab Economics with Pearson eText -- Access Card -- for Microeconomics
2nd Edition
ISBN: 9780134519517
Author: Daron Acemoglu, David Laibson, John List
Publisher: PEARSON
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Question
Chapter 15, Problem 10P
(a)
To determine
Expected value of wealth.
(b)
To determine
Whether the insurance policy offered by the company is fair.
(c)
To determine
Whether an individual will purchase an insurance policy and act as a risk-averse.
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An investor is considering three strategies for a $1,000 investment. The probable returns are estimated as follows: • Strategy 1: A profit of $10,000 with probability 0.15 and a loss of $1,000 with probability 0.85 • Strategy 2: A profit of $1,000 with probability 0.50, a profit of $500 with probability 0.30, and a loss of $500 with probability 0.20 • Strategy 3: A certain profit of $400 Which strategy has the highest expected profit? Explain why you would or would not advise the investor to adopt this strategy.
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. Priyanka has an income of £90,000 and is a von Neumann-Morgenstern expected utility maximiser with von Neumann-Morgenstern utility index u(x) = square root x. There is a 1 % probability that there is flooding damage at her house. The repair of the damage would cost £80,000 which would reduce the income to £10,000.
a) Would Priyanka be willing to spend £500 to purchase an insurance policy that would fully insure her against this loss? Explain.
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Chapter 15 Solutions
MyLab Economics with Pearson eText -- Access Card -- for Microeconomics
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Similar questions
- Review the concept of value at risk (VaR) in chapter 5. Evaluate the following two cases and decide which of the two situations would be less risky using VaR. 1. You are unemployed and are thinking about using your life savings of $10,000 to start a new business. 2. You have a full-time job paying $80,000 per year and are considering making a $1,000 investment in the stock of a well established, stable companyarrow_forwardIf a risk-averse individual owns a home worth $100,000, and that individual is willing to pay $1,000 for an annual fire insurance policy that covers the entire loss in the event of a fire, then we know that?arrow_forwardShow, using equations or a diagram, that an expected utility maximizer requires a higher return for a riskier assetarrow_forward
- Explain what is the risk premium?arrow_forwardIf a risk‐neutral individual owns a home worth $200,000 and there is a three percent chance the home will be destroyed by fire in the next year, then we know that:a) He is willing to pay much more than $6,000 for full cover.b) He is willing to pay much less than $6,000 for full cover.c) He is willing to pay at most $6,000 for full cover.d) None of the above are correct.e) All of the above are correct.arrow_forwardThe manager of XYZ Company is introducing a new product that will yield $1,000 in profits if the economy does not go into a recession. However, if a recession occurs, demand for the normal good will fall so sharply that the company will lose $4,000. If economists project that there is a 10 percent chance the economy will go into a recession, what are the expected profits to XYZ Company of introducing the new product? How risky is the introduction of the new product?arrow_forward
- Define risk aversion and give an example of a risk-averse person?arrow_forwardJamal has a utility function U = W1/2, where W is his wealth in millions of dollars and U is the utility he obtains from that wealth. In the final stage of a game show, the host offers Jamal a choice between (A) $4 million for sure, or (B) a gamble that pays $1 million with probability 0.6 and $9 million with probability 0.4. (1) Does A or B offer Jamal a higher expected utility? Explain your reasoning with calculations. (2) Should Jamal pick A or B? Why? I would like help with the unanswered last parts of the questions.arrow_forwardList three different ways that a risk-averse person can reduce financial risk.arrow_forward
- Define risk-seeking.arrow_forwardQ. 4 Suppose you, owner and CEO of a corporation, are considering a $25 million project that constructs a building in the downtown area of Toronto. The current market price of the similar building is about $20 million. The future price is uncertain. It may be either $28 million or $22 million in one year from now, depending on the economic situation. The company can borrow at a risk-free rate of 5 percent per year. What is the value of this project? Use a binomial model to value this real option.arrow_forwardGary likes to gamble. Donna offers to bet him $31 on the outcome of a boat race. If Gary’s boat wins, Donna would give him $31. If Gary’s boat does not win, Gary would give her $31. Gary’s utility function is p1x^21+p2x^22, where p1 and p2 are the probabilities of events 1 and 2 and where x1 and x2 are his wealth if events 1 and 2 occur respectively. Gary’s total wealth is currently only $80 and he believes that the probability that he will win the race is 0.3. Which of the following is correct? (please submit the number corresponding to the correct answer). Taking the bet would reduce his expected utility. Taking the bet would leave his expected utility unchanged. Taking the bet would increase his expected utility. There is not enough information to determine whether taking the bet would increase or decrease his expected utility. The information given in the problem is self-contradictory.arrow_forward
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