Question

The graph below shows the costs and benefits of theft-proofing one's home. The marginal costs increase as more precaution is taken: It's cheap to install good locks but more difficult to install invisible laser intruder-detection systems. The marginal benefit declines as more precaution is taken: If I am a burglar, adding a guard dog isn't going to provide much deterrence if you already have an electric fence and a lock on each door and window 2 9 MB MC Marginal Cost of private security against theft Marginal Benefit from private security against theft Quantity of private precautionary measures Determine the optimal amount of precaution the homeowner would take if theft insurance were unavailable a. Suppose that the homeowner can obtain an insurance policy that covers half of any losses he might suffer. Assuming that the marginal benefit curve represents the losses to the homeowner in sterling pounds, shift the marginal benefit curve an appropriate distance and determine what happens to the homeowner's optimal amount of care. What type of incentive problem does the insurance company confront? b. Suppose that the insurance company decides to institute a deductible: The c. homeowner pays the first £5,000 of losses, and after that the insurance company splits the losses with the homeowner 50-50. Shift the marginal benefit curve an appropriate amount (be sure to indicate the magnitude of the shift in an exact fashion on the graph). What effect does the deductible have on the precautions taken by the homeowner? 4 Assume that the insurance company subsidises the expense of anti-burglar equipment by covering a proportion of its cost. Discuss and show graphically, the effect of this subsidy on the precautions taken by the homeowner without deductible d. (Each sub-question carries the same weight)

Answer 1

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