1) Insurance and social policy
You are making an app with a 5% chance of making a ton-load of money, and 95% chance of earning nothing. Your utility is the square root of income (Utility = Y1/2); you will have $10,000,0001/2 happiness if your app succeeds but 01/2 happiness if it fails.
a) (2 points) What is the expected value of your app? How much money can you expect to make? What is your utility at that income (if you know that your income will be the expected value of your app)?
Note that in EXCEL, the square root function is â=X^.5â for the number X
b) (1 point) What is your expected utility from your app? (Note: this is the weighted average of utility when the app succeeds and when it fails where the weight is the probability of success.)
c) (2 points) Why do people buy insurance? How can insurance companies profit? What happens to expected utility when people can buy insurance at a fair market price?
d) (2 points) What is moral hazard and what is adverse selection. How do these affect insurance markets? Give examples from the marketing of veterinary insurance. Would you expect markets with moral hazard and adverse selection to provide the optimal amount of veterinary insurance at an efficient price?
1) Insurance and social policy
You are making an app with a 5% chance of making a ton-load of money, and 95% chance of earning nothing. Your utility is the square root of income (Utility = Y1/2); you will have $10,000,0001/2 happiness if your app succeeds but 01/2 happiness if it fails.
a) (2 points) What is the expected value of your app? How much money can you expect to make? What is your utility at that income (if you know that your income will be the expected value of your app)?
Note that in EXCEL, the square root function is â=X^.5â for the number X
b) (1 point) What is your expected utility from your app? (Note: this is the weighted average of utility when the app succeeds and when it fails where the weight is the probability of success.)
c) (2 points) Why do people buy insurance? How can insurance companies profit? What happens to expected utility when people can buy insurance at a fair market price?
d) (2 points) What is moral hazard and what is adverse selection. How do these affect insurance markets? Give examples from the marketing of veterinary insurance. Would you expect markets with moral hazard and adverse selection to provide the optimal amount of veterinary insurance at an efficient price?
