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1*. Maria’s house is worth 1 000 000 SEK. Her utility function is given by U...

1*. Maria’s house is worth 1 000 000 SEK. Her utility function is given by U = m0,5, where m represents her wealth (the value of the house). The probability of the house burning down is 0,2. A fire would reduce the house value to 300 000 SEK.

A) Express Maria’s expected utility of the lottery if she buys insurance. B) What value of K will Maria choose (that is, what value of K maximizes her expected utility)? C) Suppose Joseph is in the same situation as Maria, i.e., his house is worth 1 000 000 SEK. His utility function is given by U = m0,5, where m represents her wealth (the value of the house). The probability of the house burning down is 0,2. A fire would reduce the house value to 300 000 SEK. Fires in the houses are independent in the statistical sense. Is it beneficial for Maria and Joseph to establish a mutual insurance company whereby they share losses? Calculate Maria’s new expected utility given that they have created a mutual insurance company and discuss the result.

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