econ2 ps#4 answer key

# econ2 ps#4 answer key - < Problem Set IV Answer Key >(ECON...

This preview shows pages 1–2. Sign up to view the full content.

1 < Problem Set IV: Answer Key > (ECON 2: Spring 2008) ( Market Imperfection and Policies; Prof. Young-Han Kim ) 1. Explain the relationship between three different types of the utility wealth curves of persons, (i.e., concave, convex, and straight line) and their attitude toward risk. (That is, explain the relationship between ‘the diminishing, increasing, and constant marginal utility of wealth ’ of persons, and their attitudes toward risks.) O Diminishing marginal utility of wealth Æ Concave utility of wealth curve Æ Risk averse attitude : To Risk averse people, the utility from an expected wealth under risks is equal to the utility from (much) lower assured wealth without risks. O Constant Marginal utility of wealth Æ linear (straight-line) ‘utility of wealth curve’ Æ Risk neutral attitude: To Risk neutral people, the utility from an expected wealth under risks is equal to the utility from the same level of assured wealth without risks. O Increasing marginal utility of wealth Æ Convex utility of wealth curve Æ Risk loving attitude : To Risk loving people, the utility from an expected wealth under risks is equal to the utility from (much) higher assured wealth without risks. 2. Assume that Gina, our capable TA, bought a car, which values 10,000 dollars. When the car accident happens, the value of the car becomes 0. The probability for a car accident to happen in San Diego region is 20%. Gina is risk averse. So, her utility from the expected wealth under uncertainty (with probability for an accident to be 20%) is 90. However, she gets the same level of utility (90) with assured wealth of \$6,000 under no uncertainty. i) When an insurance company provides car insurance guaranteeing a full recovery of wealth from whatever car accident, what would be the ‘minimum cost of insurance”? (Provide your logic using diagrams in addition to the numerical answer.) o The minimum cost of insurance is the difference between the original asset value not under any risks and the expected asset value under risks. That is, the minimum cost of the insurance is the expected cost of insurance guaranteeing the original asset values not under uncertainty. In this example, the minimum cost of insurance is: \$10,000 - \$8,000 = \$2,000.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern