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Utility maximization problem of individual

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Reference no: EM132414981

A risk-neutral individual has the utility function u(w) = aw, where w is her wealth, and a>0 a parameter. Her initial wealth is equal to W. There might be a fire which would destroy the dollar amount L of this wealth. The fire occurs with probability p. The individual can buy insurance to cover the amount K, with K∈[0,L]. The insurance premium is given by g, so that if she buys insurance to cover an amount K, she must pay the insurance company the amount gK.

Solve the expected utility maximization problem of this individual to determine how much insurance she would buy. From the first-order condition you obtain, determine how much insurance she will buy in each of the following cases:

a) The insurance market is competitive.

b) The insurance market is characterized by imperfect competition, so that insurance companies have market power.

c) The insurance market is competitive, but the government subsidizes insurance companies, so that when a firm sells insurance for a coverage of K, it receives from the government the amount sK.

Reference no: EM132414981

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