Intermediate Microeconomics and Its Application 12th Edition by Walter Nicholson,Christopher Snyder

Exercise 38

This problem is based on the two-state model in the appendix to this chapter. Leah, who recently graduated from college, is deciding whether to purchase renter's insurance, which insures one's personal property in an apartment against accidents or theft, from Gecko Insurance. The following questions direct you to use diagrams to analyze her decision.
a. Use a two-state diagram along the lines of Figure 4A.3 to explain why Leah could benefit from renter's insurance.
b. Suppose Leah is risk neutral. Use a diagram to determine whether she would buy fair insurance. Would she buy unfair insurance in her favor? Would she buy insurance that provides Gecko Insurance with a profit margin above what is needed to offset the expected loss (in other words, unfair insurance in Gecko's favor)?
c. Suppose again that Leah is risk averse but that now the chance of accident or theft is extremely remote. Use a diagram to explain why she would not be inclined to buy unfair insurance in Gecko's favor.