1. If June is deemed strictly risk averse, this means that she always prefers a certain outcome to a risky one with the same expected wealth. In other words, she would rather have a guaranteed amount of wealth than face a gamble with the same expected value but some risk of getting less.

2. In terms of her utility function, strict risk aversion implies that the utility function is strictly concave. This means that the utility function has a diminishing marginal utility of wealth: the more wealth she has, the less additional utility she gets from an extra unit of wealth.

3. On the diagram from part (a), her indifference curves would be strictly convex to the origin. This means that for any two bundles of state-contingent wealth, she would always prefer a certain mixture of the two bundles to a gamble that yields one or the other with equal probability.

4. Now, suppose June can purchase insurance for the transport of her household effects at a price of q per dollar of coverage. If she chooses a policy that covers a maximum of C in the event of a loss, she pays qC to the insurance company and they agree to pay her in the event of a loss, the value of her loss up to the agreed maximum cover of C.

5. If she takes out a policy with the maximum coverage of L, then she will be fully insured in the event of the truck crashing. Her state-contingent wealth will be M - qL in the event the truck does not crash and M - qL in the event the truck crashes.

6. On the diagram, this would be represented by a movement from the point without insurance towards the 45-degree line, which represents equal wealth in both states. The exact point on the line would depend on the price of the insurance and the maximum coverage.

7. Because June is strictly risk averse, she would prefer to be fully insured if the insurance is actuarially fair (i.e., the premium equals the expected loss), and partially insured if the insurance is actuarially unfair (i.e., the premium is greater than the expected loss). The optimal insurance for June would be the one that gets her on the highest possible indifference curve, given the cost of the insurance.

Question

1. If June is deemed strictly risk averse, this means that she always prefers a certain outcome to a risky one with the same expected wealth. In other words, she would rather have a guaranteed amount of wealth than face a gamble with the same expected value but some risk of getting less.

2. In terms of her utility function, strict risk aversion implies that the utility function is strictly concave. This means that the utility function has a diminishing marginal utility of wealth: the more wealth she has, the less additional utility she gets from an extra unit of wealth.

3. On the diagram from part (a), her indifference curves would be strictly convex to the origin. This means that for any two bundles of state-contingent wealth, she would always prefer a certain mixture of the two bundles to a gamble that yields one or the other with equal probability.

4. Now, suppose June can purchase insurance for the transport of her household effects at a price of q per dollar of coverage. If she chooses a policy that covers a maximum of C in the event of a loss, she pays qC to the insurance company and they agree to pay her in the event of a loss, the value of her loss up to the agreed maximum cover of C.

5. If she takes out a policy with the maximum coverage of L, then she will be fully insured in the event of the truck crashing. Her state-contingent wealth will be M - qL in the event the truck does not crash and M - qL in the event the truck crashes.

6. On the diagram, this would be represented by a movement from the point without insurance towards the 45-degree line, which represents equal wealth in both states. The exact point on the line would depend on the price of the insurance and the maximum coverage.

7. Because June is strictly risk averse, she would prefer to be fully insured if the insurance is actuarially fair (i.e., the premium equals the expected loss), and partially insured if the insurance is actuarially unfair (i.e., the premium is greater than the expected loss). The optimal insurance for June would be the one that gets her on the highest possible indifference curve, given the cost of the insurance.

Knowee AI · Accepted Answer

1. If June is deemed strictly risk averse, this means that she always prefers a certain outcome to a risky one with the same expected wealth. In other words, she would rather have a guaranteed amount of wealth than face a gamble with the same expected value but some risk of getting less.

2. In terms of her utility function, strict risk aversion implies that the utility function is strictly concave. This means that the utility function has a diminishing marginal utility of wealth: the more wealth she has, the less additional utility she gets from an extra unit of wealth.

3. On the diagram from part (a), her indifference curves would be strictly convex to the origin. This means that for any two bundles of state-contingent wealth, she would always prefer a certain mixture of the two bundles to a gamble that yields one or the other with equal probability.

4. Now, suppose June can purchase insurance for the transport of her household effects at a price of q per dollar of coverage. If she chooses a policy that covers a maximum of C in the event of a loss, she pays qC to the insurance company and they agree to pay her in the event of a loss, the value of her loss up to the agreed maximum cover of C.

5. If she takes out a policy with the maximum coverage of L, then she will be fully insured in the event of the truck crashing. Her state-contingent wealth will be M - qL in the event the truck does not crash and M - qL in the event the truck crashes.

6. On the diagram, this would be represented by a movement from the point without insurance towards the 45-degree line, which represents equal wealth in both states. The exact point on the line would depend on the price of the insurance and the maximum coverage.

7. Because June is strictly risk averse, she would prefer to be fully insured if the insurance is actuarially fair (i.e., the premium equals the expected loss), and partially insured if the insurance is actuarially unfair (i.e., the premium is greater than the expected loss). The optimal insurance for June would be the one that gets her on the highest possible indifference curve, given the cost of the insurance.

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