Answer to Question #161299 in Microeconomics for Merki Kaleb

Question

1.     A risk-averse person has wealth y0 and faces a risk of loss L < y0 with probability. An insurance company offers cover of the loss at a premium L. It is possible to take out partial cover on a pro-rata basis, so that an amount  of the loss can be covered at cost  where.

a)      Explain why the person will not choose full insurance

b)      Find the conditions that will determine t*, the optimal value of.

c)      Show how will change as increases if all other parameters remain unchanged.

Answer 1

a) The person will not choose full insurance, because expected cost of using it is higher.

b) To find the conditions that will determine t*, we need to know what is t*.

c) There will be no change in expected value or cost if all other parameters remain unchanged.