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Unformatted text preview: Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1 1 Reducing Risk: Insurance 14.01 Principles of Microeconomics, Fall 2007 Chia-Hui Chen September 28, 2007 Lecture 10 Insurance and Production Function Outline 1. Chap 5: Reducing Risk: Insurance 2. Chap 6: Outline of Producer Theory 3. Chap 6: Production Function: Short Run and Long Run 1 Reducing Risk: Insurance Reducing Risk: Diversification Insurance Example (House insurance) . Assume that one house has the proba- bility p to catch fire, with loss l each time, i.e. the owners wealth will reduce from y 1 to y 2 = y 1 l . If the owner pay premium k to buy an insurance which covers the loss l when there is a fire, her wealth will be y 3 = y 1 k , for the situations listed (see Table 1). No Insurance Insurance No Fire y 1 y 3 = y 1 k Fire y 2 = y 1 l y 3 = y 1 k Table 1: Wealth of House Owner in Different Situations....
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