Question

True/False with a short explanation

1. The index in an index insurance contract should be highly correlated with the actions that farmers take to reduce the probability of harvest failure.

2. The Net Benefit Ratio (NBR) captures how a specific price change is likely to affect a given household.

3. Household members tend to have different preferences, but empirical evidence shows that overall, most households are Pareto-efficient.

4. For risk-averse individuals, having a greater ability to do consumption smoothing means they are more likely to choose profitably but risky activities.

Answer 1

1. True

With index-based insurance, payouts are related to an “index” that is closely correlated to agricultural production losses, such as one based on rainfall, yield or vegetation levels (e.g. pasture for livestock). Payouts are made when the index exceeds a certain threshold, often referred to as a “trigger”.

2. False

3. False

Pareto efficiency, or Pareto optimality, is an economic state where resources cannot be reallocated to make one individual better off without making at least one individual worse off. Pareto efficiency implies that resources are allocated in the most economically efficient manner, but does not imply equality or fairness.

4. False

A risk averse investor is an investor who prefers lower returns with known risks rather than higher returns with unknown risks.