PS 4_Unsolved

# PS 4_Unsolved - Problem Set #4 Micro II Spring Term 2011...

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Problem Set #4 Micro II – Spring Term 2011 Due Date: 12 th April, 2011 1. Donald is a risk-averse person who has \$100 in monetary wealth and owns a  house worth \$300. The probability that his house is destroyed by fire (equivalent to a  loss of \$300) is p ne  = 0.5. If he exerts an effort level e = 0.3 to keep his house safe,  the probability falls to p e  = 0.2. His utility function is: U = w 0.5  – e  where e is effort level exerted (zero in the case of no effort and 0.3 in the case of effort). a. In the absence of insurance, does Donald exert effort to lower the probability of  fire? b. Donald is considering buying fire insurance. The insurance agent explains that a  home owner’s insurance policy would require paying a premium   and would α   repay the value of the house in the event of fire, minus a deductible D. [A  deductible is an amount of money that the company does not reimburse in the

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## This note was uploaded on 02/13/2012 for the course ECON 121 taught by Professor Adam during the Spring '11 term at Bunker Hill.

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PS 4_Unsolved - Problem Set #4 Micro II Spring Term 2011...

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