-Mike has the utility of wealth curve shown in the figure above. He owns a car worth $20,000, and that is his only wealth. There is a 10 percent chance that Mike will have an accident within a year. If he does have an accident, his car is worthless.
a) What is Mike's expected utility?
b) What is the maximum amount that Mike is willing to pay for auto insurance?
c) Suppose all car owners are like Mike insofar as they have a 10 percent chance of having an accident. An insurance company agrees to pay each person who has an accident the full value of his or her car. The company's operating expenses are $1,000. What is the minimum insurance premium that the company is willing to accept?
d) Will Mike buy the company's policy? Why or why not?
Definitions:
Degrees of Freedom
Refers to the number of independent values or quantities which can be assigned to a statistical distribution.
Critical Value
A point on the scale of the test statistic beyond which we reject the null hypothesis, representing a threshold chosen to determine the significance of the test statistic.
Independent Variables
Factors that are manipulated or changed in an experiment to determine their effect on dependent variables.
Multiple Coefficient
Often refers to the coefficient of determination (R^2) in multiple regression analysis, indicating the proportion of variance in the dependent variable predictable from the independent variables.
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