What is the actuarially fair price of insurance in situation

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Reference no: EM13977056

Ms. Fogg is planning an around-the-world trip on which she plans to spend $10,000. Her utility from the trip is a function of how much she actually spends on it (Y), given by:

U(Y) = ln Y.

(a) If there is a 25% probability that Ms. Fogg will lose $1000 of her cash on the trip, what is her expected utility from the trip?

(b) Suppose that Ms. Fogg can buy insurance against losing the $1000 at an actuarially fair premium of $250. Will Ms. Fogg purchase the insurance?

(d) Suppose that people who buy insurance tend to become more careless with their cash and that their probability of losing $1000 rises to 30%. What is the actuarially fair price of insurance in this situation? Will Ms. Fogg buy insurance now?

(e) Have we illustrated a case of adverse selection or moral hazard? Explain.

Reference no: EM13977056

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