Consider an individual who faces a gamble over two outcomes

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Consider an individual who faces a gamble over two outcomes, In the first outcome he maintains the wealth of w1, and in the second outcome he faces a loss of wealth and is left with a final amount of w2.

a. In a utility-wealth graph, draw the utility function of a risk adverse individual, label the two wealth levels, and label the two utilities associated with those wealth levels. Explain why the utility function you have drawn in your graph depicts a risk adverse individual.

b. Suppose the risk of loss to w2 is 25 percent. Using your diagram depicts expected wealth and the utility associated with having the level of expected wealth for certain. Next, use your diagram to show this individual’s expected utility

c. Consider an actuarially fair price for insurance. Would the individual you have depicted above have positive demand for insurance? Use your diagram to explain why?

Reference no: EM13771779

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