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Unformatted text preview: Intermediate Microeconomics, 2008 Problem Set No7b: Solutions Problems 1) What would be the price of fair insurance for a $20 , 000 motor home for one year, assuming that during that year there is a . 02% chance that it will be destroyed in an accident, leaving a $3 , 000 salvage value and no chance of any partial loss? Assume that the owner keeps the salvage value. I assume that the chance of an accident is 2%. The expected value of the motor home is (0 . 02)(3000)+ (0 . 98)(20000) = 19660. Therefore, fair insurance should leave the consumer with $19 , 660 in the case of an accident or no accident. So, if there is no accident the consumer must pay 20000- 19660 = 340 dollars for the insurance. 2) An individual has an initial wealth of $35 , 000 and might incur a loss of $10 , 000 with probability p . Insurance is available that charges $ g to purchase $1 of coverage. What value of g will make the insurance actuarially fair? If she is risk averse and insurance is fair, what is the optimal amountinsurance actuarially fair?...
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This note was uploaded on 12/10/2011 for the course ECON 401 taught by Professor Burbidge,john during the Winter '08 term at Waterloo.
- Winter '08