Risk-averse individual prefers a gamble to a certain amount

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Reference no: EM1315110

Q. Please read the lecture notes + the relevant chapter in Varian.

Say which Mr. A has €50,000 of safe assets also possesses a house worth €200,000. There is the possibility Elucidate however which the house could burn down, in which case the property is only worth €40,000 (this is the value of the land on which it stands). The probability of the fire occurring is 0.01. Mr A. is risk-averse, with a utility of wealth function.

(a) Illustrate what is Mr. A's expected utility if no fire insurance is purchased?

(b) Illustrate what is Mr. A's "certainty equivalent" income? Utilize this concept to construct an example in which a risk-averse individual prefers a gamble to a certain amount of money.

Reference no: EM1315110

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