Question

Suppose that your utility function is U = √ I where I is the amount of...

Suppose that your utility function is U = √ I where I is the amount of income you make per month. Suppose that you typically make $8,100 per month, but there is a 5 percent chance that, in the next month, you will get sick and lose $3,200 in income.

(a) What is your expected utility if you do not have health insurance to protect against this adverse event? [1 mark]

(b) Suppose you can buy insurance that will fully cover your losses if you get sick. What would be the actuarially fair premium? [1 mark]

(c) What is your expected utility if you buy the insurance policy at an actuarially fair premium? [1 mark]

(d) What is the most that you would be willing to pay for this policy? [1 mark]

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