Question

2) (20 points) Lynn has a utility function U(W) = W1/2, where W is the amount of wealth that she has. Lynn has two assets. She has $40,000 in a bank account, and she has a house worth $600,000, so her total wealth is initially $640,000. There is a 2% chance that her house is destroyed by a fire.

a) (4 points) Considering the probability that there is a fire, what is Lynn’s Expected Wealth, E(W)?

E(W) = ____________________________

b) (4 points) What is Lynn’s Expected Utility, E(U)?

E(U) = ______________________________

c) (4 points) What is Lynn’s Certainty Equivalent?

CE = ______________________________

d) (4 points) How much would Lynn be willing to pay for fire insurance?

WTP = _______________________________

e) (4 points) What is Lynn’s Risk Premium?

Risk Premium = _____________________________

Answer 1

G→ Good State toGE G40000 o 40,000 hrs 63%800+ 800-6881000 8A 640 000 02 451000 = .98 x 800 + ,02 x 200 484 t 4 188 Ang G) Ce d) wiling ness to pauy hos insusan ce - nthal uw eath -p 19,0564 Ani