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Aug 22nd, 2016
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Economics 103Professor FriedmanSpring 2014Your Name: Layla Fahoum.Your TA: Myles Day.Your Section Time and Day: Friday 12:20-1:10 .Problem Set 3Due Date: May 7thHand in hard copy in your TAs mailbox, 8th floor of ThompsonDo not submit answers on line through MoodleTotal 20 points.1) (8 points) Insurancea) (2 points) Suppose a farmers crop is worth $100,000 when the crop is successful whichhappens 90% of the time. But there is a 10% chance of a bug infestation destroying it,leaving him with $0. Suppose his utility is the square root of his income (U = Y) so hisutility is 100000 when the crop is successful and 0 when the bugs come. What wouldbe the price, P, of a risk-neutral insurance plan where the farmers pays P for sure inexchange for a $100,000 payout in the event of infestation? What is the maximum pricethe farmer is willing to pay? (Hint: what is his expected utility with and withoutinsurance? The premium is the maximum amount that he would sacrifice to beguaranteed as much utility as he would have without insurance.)Note that in EXCEL, the square root function is =SQRT(X) for the number X; or=X^.5A risk neutral insurance plan means that the insurance company doesnt getanything in return, what is paid to them is paid back within time. There is only a 10%chance of a failure this means from every 10 crops only one will fail. Therefore if he paid10% of his income every time the crop is good, on that year that it do

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