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19 March, 18:54

There is a 10% chance you will get in a serious car accident, incurring damage of $1,990. (There is a 90% chance that nothing will happen.) Your utility function is U (I) equals square root of I. What is the fair price of this policy

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  1. 19 March, 21:13
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    The answer is $199

    Explanation:

    Solution

    Given that:

    There is fair chance of 10% of you involving in an accident.

    The damage incurred is = $1990

    There is 90% chance that nothing will happen'

    Utility function U (1) √1

    Now,

    We find the fair price of this policy

    A fair premium is the amount that enables insurance company to break exactly even. that is to say

    economic zero profit = expected costs.

    Thus,

    EC = p * (The loss of income if the accidents take place) + 1 - p (The income loss when accidents foes not take place)

    EC = 0.1 ($1990) + 0.9 (0) =

    EC = $199 + 0 = $199

    Therefore, the fair price of this policy is $199
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