Compute the premium fee set by the insurer

Assignment Help Microeconomics

Reference no: EM132174830

Question: Consider an economy in which there are two types of risk-averse individuals. Type 1 risks losing $10 with 40 percent probability and nothing with 60 percent probability. Type 2 is in a riskier situation: with 80 percent probability, she loses $10, and with 20 percent probability she does not lose anything. Sixty percent of all individuals are of type 1, and 40 percent of type 2. Assume that the two types have the same utility function: u = (w0.6/0.6) where w is wealth. Both types of individuals are endowed with the same initial wealth w = $50. There is a risk-neutral insurer offering full insurance. This insurer is an NGO that just wants to break even, and suppose that there is no "loading factor" (i.e., no cost of providing insurance, so the insurer sets prices that are actuarially fair). The insurer can not distinguish between the two types, and thus has to charge the same premium to both types.

a. Compute the premium fee set by the insurer.

b. With this level of risk premium, which of the two types will purchase insurance? Explain your answer.

c. If the insurer anticipates that only individuals of type 2 will buy insurance, what is the premium charged in this case? Explain whether individuals of type 2 will ultimately buy insurance.

Reference no: EM132174830

Questions Cloud

Could larry be the father of jane baby : Larry's mother has type AB blood and Larry's father has type O blood. Could Larry be the father of Jane's baby?

High percentage crop turnovers : How do GMOs have the ability to be grow in rough areas and still have high percentage crop turnovers?

What is a functional domain of a protein : Sequencing of the human genome revealed that functional domains of proteins are often encoded in a single exon. What is a functional domain of a protein?

Hydroquinone or resorcinol be used as a substrate : What is a structural isomer, and can either hydroquinone or resorcinol be used as a substrate?

Compute the premium fee set by the insurer : Consider an economy in which there are two types of risk-averse individuals. Type 1 risks losing $10 with 40 percent probability and nothing with 60 percent.

Show that relative to individual one : Suppose that there are two risk-averse individuals with the same utility function u = (w0.7/0.7), where w is wealth. Their initial wealth endowment.

Will there be any investment at given date : Consider again an economy like the one described in except that in this case all individuals face the risk of a negative shock at the end of period 2.

Show that the two types will invest in one project : Moreover, suppose that all individuals are very patient, that is, that their discount factor ß = 1. All borrowers are protected by limited liability.

Can you make similar cases for subsidizing micro saving : Arguments for subsidizing small loans have long been made. Can you make similar cases for subsidizing micro saving? On grounds of equity?

User Account

All Pages