Suppose There Exists Only One Type of Auto- Insurance Policy

question 68

Multiple Choice

Suppose there exists only one type of auto- insurance policy, and that all the individuals are
Risk- averse. Seventy- five percent of the population consists of low- risk individuals, each of whom has a 10% chance of being in a car accident that causes $5,000 worth of damage. The remainder of the population has a 60% chance of being in such an accident. Given a competitive insurance market consisting of risk- neutral firms that incur no operating expenses, what will be the equilibrium price for full coverage?

• A)$525
• B)$1,125
• C)Either $3,000, or $1,125
• D)$3,000

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Definitions:

Fixed Expenses

Costs that do not change in total despite changes in the level of business activity or production volume, such as rent or salaries.

Target Net Profit

A financial objective set by a business indicating the desired bottom-line income after all expenses, interest, and taxes have been deducted from total revenues.

Degree of Operating Leverage

A measure of how much a company's operating income changes in response to a change in sales volume, indicating the level of fixed versus variable costs.

Contribution Margin

The amount remaining from sales revenue after all variable expenses have been deducted, indicating the ability to cover fixed costs and generate profit.