How do we determine the value (willingness to pay) for insurance?
What will be an ideal response?
The amount that someone would be willing to pay to avoid risk is measured using the person's utility of wealth schedule or curve. The important feature of the curve is that the marginal utility of wealth diminishes as wealth increases. The rate at which the marginal utility of wealth declines determines the degree of the individual's risk aversion, that is, how much he or she is willing to pay to avoid risk.
Suppose a person faces the risky situation of receiving wealth of (with utility of ) or a smaller amount, (with utility of ). The expected wealth from this situation is EW, and the expected utility is EU. This risky situation has the same utility as receiving some amount of certain wealth, W. The difference in wealth between the risky high level of wealth and the sure case, – W, measures the value of insurance in this situation to this individual. The more rapidly the marginal utility of wealth declines, the more risk averse is the person because the more wealth the individual is willing to give up to guarantee a certain (albeit lower) amount of wealth. That is, the more concave the utility of wealth curve, the less is the certain wealth that has the same utility as the expected utility from an uncertain, risky outcome.
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As the number of firms in an oligopolistic market increases, ________
A) prices tend to decline toward marginal cost B) prices tend to rise above marginal cost C) the market demand for the good tends to fall D) profits earned by firms tend to rise
Fiscal policy during periods of relatively low unemployment and low inflation have
A) little effect due to time lags and the crowding-out effect. B) significant effect due to the timely intervention of the president and congress. C) significant effect because the changes in fiscal policy gives investors confidence in the economy. D) little effect because the global market makes up fifty percent of aggregate spending.