Suppose you rent an apartment and are worried about a break-in that results in theft of your property.Suppose your monthly consumption level is currently $4,000 but a break-in would result in you having to finance your purchase of replacement property -- and this would reduce your current consumption to $2,000 per month.There is a 10% chance of a break-in,and your tastes can be modeled with the expected utility form using the function $u ( x ) = x ^ { 0.75 }$ .
a.What is the utility of the expected value of the gamble you face,and what is the expected utility of the gamble?
b.How does your answer to (a)change if the probability of a break-in increases to 20%?
c.What is the certainty equivalent and the risk premium in each case?
d.What equation would you have to solve to get the answer to the following: How much would you be willing to pay to keep the crime rate in your area from increasing (i.e.to keep the probability of a break in to 10% rather than have it rise to 20%)assuming there is no rental insurance available in your area?
e.What would you be willing to pay to avoid the increase in the crime rate if there is a full menu of actuarily fair rental insurance available at all times?

Question

Suppose you rent an apartment and are worried about a break-in that results in theft of your property.Suppose your monthly consumption level is currently $4,000 but a break-in would result in you having to finance your purchase of replacement property -- and this would reduce your current consumption to $2,000 per month.There is a 10% chance of a break-in,and your tastes can be modeled with the expected utility form using the function $u ( x ) = x ^ { 0.75 }$ . 
a.What is the utility of the expected value of the gamble you face,and what is the expected utility of the gamble?
b.How does your answer to (a)change if the probability of a break-in increases to 20%?
c.What is the certainty equivalent and the risk premium in each case?
d.What equation would you have to solve to get the answer to the following: How much would you be willing to pay to keep the crime rate in your area from increasing (i.e.to keep the probability of a break in to 10% rather than have it rise to 20%)assuming there is no rental insurance available in your area?
e.What would you be willing to pay to avoid the increase in the crime rate if there is a full menu of actuarily fair rental insurance available at all times?

Quizplus · Accepted Answer

The Answer of Suppose you rent an apartment and are worried about a break-in that results in theft of your property.Suppose your monthly consumption level is currently $4,000 but a break-in would result in you having to finance your purchase of replacement property -- and this would reduce your current consumption to $2,000 per month.There is a 10% chance of a break-in,and your tastes can be modeled with the expected utility form using the function $u ( x ) = x ^ { 0.75 }$ . 
a.What is the utility of the expected value of the gamble you face,and what is the expected utility of the gamble?
b.How does your answer to (a)change if the probability of a break-in increases to 20%?
c.What is the certainty equivalent and the risk premium in each case?
d.What equation would you have to solve to get the answer to the following: How much would you be willing to pay to keep the crime rate in your area from increasing (i.e.to keep the probability of a break in to 10% rather than have it rise to 20%)assuming there is no rental insurance available in your area?
e.What would you be willing to pay to avoid the increase in the crime rate if there is a full menu of actuarily fair rental insurance available at all times?

Suppose You Rent an Apartment and Are Worried About a Break-In