Essentials of Economics (MindTap Course List)
8th Edition
ISBN: 9781337091992
Author: N. Gregory Mankiw
Publisher: Cengage Learning
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Question
Chapter 19, Problem 4CQQ
To determine
Moral hazard and adverse selection.
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The ability of insurance to spread risk is limited bya. risk aversion and moral hazard.b. risk aversion and adverse selection.c. moral hazard and adverse selection.d. risk aversion only
Portray a utility function for money that “explains” why a person might buy a lottery ticket (and therefore appears risk acceptant) and also pur- chase a homeowner’s insurance policy (appearing risk averse).
Questions 4 & 5
Michelle owns a house in which she keeps valuables worth 100,000 which can get stolen with probability 1%. She can purchase coverage C of the amount C ∈ [0; 100,000] at premium π = 0.05 dollars for each dollar covered. Her Bernouilli utility function is u(w) = ln(w). Assume she has no other assets.
1. Set up her maximization problem.
2. How much insurance will she choose to buy?
3. How much profits does the insurance company earn on insuring Michelle?
4. Does the fact that the insurance company earn profits mean that Michelle is worse off com-pared to the situation in which she is not insured? Explain what is happening.
5. How much insurance will she buy if insurance companies charge an actuarially fair insurance rate?
Chapter 19 Solutions
Essentials of Economics (MindTap Course List)
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Similar questions
- A. From the graph below explain how an insurance plan which provides the buyer a $15,000 wealth level, regardless of any uncertain event, is a good deal for the buyer? In other words, what does the distance between points D’ and C’ represent? Note we are referring to D prime, not D. B. Considering the graph below, can you explain the difference between expected utility and certainty utility?arrow_forwardWhat term do economists use to describe the tendency for people to prefer certain outcomes over risky situations? a. The precautionary principle b. Risk differentiationc. Risk uncertainty d. Risk aversion e. Risk managementarrow_forward2. Consider an individual with a current wealth of $100,000 who faces the prospect of a 25% chance of losing $20,000 through theft of her car during the next year. If the person’s utility function is U(X) = ln(X), where X is wealth: a. calculate expected utility without insurance, b. calculate the actuarially fair premium for full insurance, c. calculate expected utility with full insurance at the actuarially fair premium d. calculate the maximum amount the individual would pay for full insurance.arrow_forward
- Discuss the differntaition between Neccesity and Luxury expendses in life. Why Islam discourage luxury life style? Discuss the role of Insurance in managing your investment risks.arrow_forwardA9 Describe an example of adverse selection that we may run into in the real world. How does adverse selection impact the policy holders for this specific type of insurance for: High risk participants? Low risk participants? What is one government regulation that has been enacted in the last 20 years that helps either high risk or low risk policy holders in the United Statesarrow_forwarda) Suppose an insurance company decides to insure the earnings obtained by a professional tennis player (in the event of an injury), provided she does not engage in activities like skydiving or skiing. Which asymmetric information problem is the insurance company trying to avoid? b) How do insurance companies protect themselves against losses due to adverse selection and moral hazard? c) How do insurance companies price their products to solve the problem of asymmetric information?arrow_forward
- B. Richard's nickname is "No-Risk Rick" because he is an extremely risk-averse individual. His utility function is given by U(W) = √W. where W represents his current wealth in dollars. He currently has $100 worth of property, but there is a 50% chance that all of it will be stolen. What is Richard's expect wealth and expected utility of wealth? An insurance company offers to reimburse Richard for his loss if the money is stolen. What is the most that Richard would pay for such a policy? Explain. Please solve this with in 1 hourarrow_forwardIf you understand the principles of insurance, you will understand why it probably makes sense to purchase insurance to guard against large losses, like the destruction of a home you own, but probably does not make sense to purchase insurance to guard against small losses, like the failure of a TV you buy.arrow_forward5. Explain how imperfect information problems such as adverse selection and moral hazard might affect the following markets or situations (also identify the problem whether adverse selection or moral hazard or both of them) a. Workers report medical history for health insurance. b. The market for used car. c. The market for automobile collision insurancearrow_forward
- Investors have different preferences with regards to the risk: they can be risk averse, risk neutral and risk seeking. What do we mean by risk averse, risk neutral, and risk seeking?arrow_forwardThe Healthcare Managers Team Challenge Question: Considering the same graph above, and assume that the probability of a hurricane in Springfield is 23% this coming summer: a) calculate the expected wealth and utility of the Simpson's residence; b) explain why Homer Simpson is likely to buy insurance, or why he might not be wanting to buy insurance. Note that if the hurricane takes place the value of the Simpsons' wealth will be $10,000. but if there is no hurricane, their wealth will remain at $20,000.arrow_forward
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