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1) (7 points) Insurance and social policy You are making a movie
with a 10% chance of making a ton-load of money, and 90% chance of
earning nothing. Your utility is the square root of income (Utility
= Y1/2); you will have $10,000,0001/2
happiness if your movie succeeds but 01/2 happiness if
it fails.

a) (1 point) What is the expected value of your movie? What is
your utility at that income? Note that in EXCEL, the square root
function is “=X^.5” for the number X b) (1 point) What is your
expected utility from your movie? (Note: this is the weighted
average of utility when the app succeeds and when it fails where
the weight is the probability of success.)

c) (1 point) What would be the price, P, of a risk-neutral
insurance plan where you have a guaranteed income of a successful
movie and the insurance company breaks even without make
profit?

d) (1 point) What is the maximum price you would be willing to
pay? (Hint: what is the expected utility with and without
insurance? The premium is the maximum amount that you would
sacrifice to be guaranteed as much utility as without
insurance.)

e) (1 point) Considering your answer to part A, in general, why
do people buy insurance? How can insurance companies profit? What
happens to expected utility when people can buy insurance at a fair
market price? f) (2 points) How else can insurance companies make
profits? What is moral hazard and what is adverse selection. How do
these affect insurance markets? Give examples from the marketing of
automobile insurance. Would you expect markets with moral hazard
and adverse selection to provide the optimal amount of car
insurance at an efficient price?