Question

Victoria has $4000 to put toward consumption this month. She believes there is a 30% chance she will have a bike accident this month, in which case she will incur medical costs of $3000 (leaving her with $1000 to put toward consumption). Victoria's utility over consumption is given by U = 0.8 where cis consumption (in dollars). In the absence of any insurance, the expected value of Victoria's consumption this month is $ 3100 . In the absence of any insurance, the expected utility Victoria receives from her consumption this month is 608 utils (enter only numbers in the blanks, and please round to the nearest whole number if necessary).

Answer 1

If Victoria purchases insurance, she will have (4000-1200) = $2800 for consumption. Now even if she has an accident, she will not have to incur any medical costs.

So the expected value of Victoria’s consumption should she purchase the insurance cover is $2800.

Expected utility should Victoria purchase insurance will be equal to the total utility as Victoria will surely have 3100 for consumption.

E(U )=
`3100^(0.8)`

E(U) = 621 (rounded off to nearest integer)