Imagine that individual preferences can be represented with U(C) - VC. In additi
ID: 1126058 • Letter: I
Question
Imagine that individual preferences can be represented with U(C) - VC. In addition, assume that C can assume either of two values CL = 1 or CH-16. Furthermore, assume that there are two-equally populous groups of individuals. In the first group the low value of consumption is more likely and occurs with 7 probability pt = 5 and in the second with probability pL2-15. Imagine that insurance companies can distinguish the two groups. Furthermore, assume that the insurance market is perfectly competitive. (1): How much should individuals in the first group be charged per dollar of coverage for complete insurance? (a) 5 (b) 5 (c) 15. Now assume that insurance companies are not able to distinguish the two groups and decide to charge x = 3 per dollar of coverage. (2): Do you expect the two groups to be interested in purchasing complete insurance now? (a) Only the first will (b) Only the second group will (c) Nobody will be interestedExplanation / Answer
Ans 1 Individual in the first group charge per dollar is
4/5 * 1= 4/5. So option b is correct answer.
Where 4/5 is PL1 and 1 is CL.
Ans 2 The correct opiton of this question is option a i.e. only first group will be interested as
7/15 = 0.46
And 4/5 = 0.80
Also that we have 2/3 = 0.66. So first group will consider it to purchase the complete insurance.