A risk averse consumer has a car valued at $10,000. There is a 10% probability that the car will be stolen this year, in which case the value of the car for the consumer is zero. For a premium $y, the consumer can buy an insurance plan that would replace the car if stolen.
The consumer has utility
. What is the maximum insurance premium $y the consumer would be willing to pay?
b. What is the risk premium the consumer is willing to pay?
Note: Insurance premium = risk premium + fair insurance premium
Fair insurance premium = expected loss
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