Here is a quick assignment regards to Public Finance: Taxation

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Problem Set 2 Public Finance – 3319 1. 2. John just purchased a new car today and paid $40K for it. He needs to go to Ottawa tonight but there is a weather warning that roads are full of black ice and dangerous to drive. The dealer can only issue a mandatory liability insurance that covers only damages to other cars and persons but not the John’s car. He knows that there is a 90% chance that he will not have an accident. But if it happens he will lose his car. Suppose that it’s late and all insurance brokers are closed, all flights are full, and he missed the last bus. Canceling the trip will cost him $4,000. He is just thinking the best possible action. Since you are his best friend taking Public Finance at SMU, he calls you to get your opinion. a) Using your own utility function and calculating expected utilities, how would you advise him? Justify your answer with numbers. b) Would you change your answer if the probability of no-accident were 99%? Why? c) What amount of cost would change your answer in (a)? Explain your answer by calculating CEW. There are two groups of people: street racers (SR) and low riders (LR). SRs have 10% chance that they will have an accident in the next 12 months. The same is true with 1% chance for LR. If an accident happens, both lose the car they own (in insurance jargon it’s called “total”). They have an identical utility function (𝑈 = √𝐶) and a car, which is worth $40K. a) Calculate the maximum premium that each group would be willing to pay for an insurance coverage. b) Calculate the premium (Pact = $ amount of loss if accident happens X probability that an accident happens) that insurance company would charge c) Calculate the consumer surplus (the increase in their well-being measured by U) for both groups if they buy the insurance coverage at the price that the insurance company charges. d) Explain how insurance company would know who is who, in other words how it distinguishes SRs from LRs. e) Is there any incentive for SR to lie about their true risk profile? If they (SRs) say (lie) they are LRs, how much increase they experience in their well-being measured by U? f) This is called asymmetric information: the information that is known by one side is not fully known by the other side. Show the insurance company’s profit if the company ignores the asymmetric information and believes that the information risk holders reveal about their risk profiles is true. ...
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MatthewRugetti
School: Boston College

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Public Finance- 3319
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PUBLIC FINANCE

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John just purchased a new car today and paid $40K for it. He needs to go to
Ottawa tonight but there is a weather warning that roads are full of black ice and
dangerous to drive. The dealer can only issue a mandatory liability insurance that
covers only damages to other cars and persons but not the John’s car. He knows
that there is a 90% chance that he will not have an accident. But if it happens, he
will lose his car. Suppose that it’s late and all insurance brokers are closed, all
flights are full, and he missed the last bus. Canceling the trip will cost him
$4,000. He is just thinking the best possible action. Since you are his best friend
taking Public Finance at SMU, he calls you to get your opinion.
a) Using your own utility function and calculating expected utilities, how
wo...

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Anonymous
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