Instructions - All graphs must be entitled Fig. 1, Fig. 2, etc., and as you writeyou should refer to these graphs by their titles. Draw BIG graphs to improveclarity.
a) Imagine a world where you are considering buying health insurance:
Probability of being healthy = 90%
Probability of getting the flu = 8%
Probability of getting pneumonia = 2%
(You can only have one of the above)
Income = $50,000
Cost of flu = $500
Cost of pneumonia = $5000
What is your expected income after paying for illness?
b) Utility = √(Income) (NOTE: This is square root of income)
Fill in the utility in the following table
|
Income
|
Utility
|
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$0
|
|
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$45,000
|
|
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$49.500
|
|
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$52,000
|
|
Draw the utility curve including each of those points.
c) If insurance costs $100 and covers the entire cost of each illness, what is the utility benefit (increase in utility) of buying insurance? (Note: round to 3 decimals)
d) What is the premium where you would be equally well off buying or not buying insurance?