To determine: The cost of a fair insure policy and if following people will take the insurances in the given situations.
Concept introduction
Expected Value: It is defined as the weighted average of probable events where the weights of each probable value corresponds to the chances of that value occurring. The formula to calculate expected value is:
Where,
- is expected value.
- is probability of event 1.
- is probability of event 2.
- is probability of event N.
- is event 1.
- is event 2.
- is event N.
Expected Utility It is defined as the value of a person’s total utility, so that there is no certainty for future results.
Fair Insurance Policy: It is an insurance policy in which the money offered by the company is equal to the expected value.
Risk Neutral: Any person who does not care for any kind of risk is known as risk neutral.
Moral Hazard: It is a situation of imperfect knowledge which leads to market failure. Example: A person who is insured against something does not bother about that thing.
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