Problem_Set_08 - Economics 1100 Intermediate Microeconomics...

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Economics 1100: Intermediate Microeconomics Spring 2011 Problem Set 8 1. Assume Johnny's utility function is a W W U = ) ( . a. For what values of a is he risk averse, risk neutral, and risk loving? From now on, assume that a = ½. Johnny owns a house that would cost $100,000 to replace should it ever be destroyed by fire. There is a 0.1% chance that the house could be destroyed during the course of a year. b. How much would fair insurance cost that completely replaces the house if destroyed by fire? c. Assuming that Johnny has no other wealth, how much would Johnny be willing to pay for such an insurance policy? 2. Alvin's utility function is U(W) = W . Barry's utility function is U(W) = W 2 . Carl's utility function is W W U = ) ( . Each has wealth of only $100. An investment of that $100 has a 10% chance of netting $1,000 and a 90% chance of netting a loss of that $100. Who among the three will make the investment? 3. Lori, who is risk averse, has two pieces of jewelry, each worth $400. She wants to send them to her sister in Mexico. She is concerned about the safety of shipping them. She believes that the probability that a
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