SOLVED

21) Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve’s utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company’s insurance policy. The company’s operating expenses are $500 per policy. What is the maximum insurance premium that Steve is willing to pay? A) $2,000 B) $500 C) $1,000 D) $1,500 22) Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve’s utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company’s insurance policy. The company’s operating expenses are $500 per policy. What is the minimum premium that the insurance company will accept? A) $1,000 B) $2,000 C) $500 D) $1,500 23) Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve’s utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company’s insurance policy. The company’s operating expenses are $500 per policy. Both Steve and the insurance company will gain if the insurance premium is A) $900 B) $1,200 C) $1,600 D) $700 24) Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve’s utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company’s insurance policy. The company’s operating expenses are $500 per policy. If Steve buys the insurance for $1,000, his expected wealth will be ________, and his expected utility will be ________ than with no insurance. A) greater; greater B) greater; less C) less; greater D) less; less 25) The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. Which of the following statements is TRUE? A) This person has diminishing marginal utility of wealth. B) This person is not risk averse. C) Risky situations cause this person no loss of utility. D) None of the above are correct. 26) The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, what is the person’s expected wealth? A) $10,000 B) $20,000 C) $30,000 D) $40,000 27) The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, what is the person’s cost of risk? A) $10,000 B) $20,000 C) $30,000 D) $40,000 28) The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, the highest price for insurance this person would pay is A) $0. B) $5,000. C) $10,000. D) $20,000. 29) The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be completely destroyed, would this homeowner buy insurance? A) No, because the homeowner is not risk averse. B) Yes, at any price because the homeowner is risk averse. C) Yes, but only if it costs less than $10,000. D) Yes, but only if it costs less than $20,000. 30) The above figure shows the utility of wealth curve for a homeowner whose only possession is a $50,000 house. If there is a 20 percent chance that the home could be entirely destroyed, would this person buy a $20,000 insurance policy to replace the house if destroyed? A) No, it is too expensive. B) No, he is not risk averse. C) Yes, the homeowner would pay even more. D) Yes, this is the most the homeowner would pay.