2. Cloneville is a town consisting on 100,000 identical citizens. Each citizen has a current total wealth of $160,000 and has a utility function given by u (w) = w². In any given year, 10% of the citizens will lose 75% of their wealth to a fire. Since the citizens are identical, they are all equally likely to experience a fire. (a) Calculate the actuarially fair premium for complete fire insurance in Cloneville. How many citizens of Cloneville would purchase insurance if it cost this much? (b) Do you think insurance companies in Cloneville are likely to offer actuarially fair insur- ance? Why or why not? (c) Nearby Simville also has 100,000 citizens with the same initial wealth and risk of fire. While no citizens in Simville are risk-loving, some are more risk-averse than others. In fact, there are even a few citizens in Simville who are risk-neutral. i. Suppose insurance is supplied by a competitive industry made up of identical in- surance companies. Costs of providing insurance include covering losses that occur ith
2. Cloneville is a town consisting on 100,000 identical citizens. Each citizen has a current total wealth of $160,000 and has a utility function given by u (w) = w². In any given year, 10% of the citizens will lose 75% of their wealth to a fire. Since the citizens are identical, they are all equally likely to experience a fire. (a) Calculate the actuarially fair premium for complete fire insurance in Cloneville. How many citizens of Cloneville would purchase insurance if it cost this much? (b) Do you think insurance companies in Cloneville are likely to offer actuarially fair insur- ance? Why or why not? (c) Nearby Simville also has 100,000 citizens with the same initial wealth and risk of fire. While no citizens in Simville are risk-loving, some are more risk-averse than others. In fact, there are even a few citizens in Simville who are risk-neutral. i. Suppose insurance is supplied by a competitive industry made up of identical in- surance companies. Costs of providing insurance include covering losses that occur ith
Chapter7: Uncertainty
Section: Chapter Questions
Problem 7.7P
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