There is a 10% chance you will get in a serious car accident, incurring damage of $1,990. (There is a 90% chance that nothing will happen.) Your utility function is U (I) equals square root of I. What is the fair price of this policy

The answer is $199

Explanation:

Solution

Given that:

There is fair chance of 10% of you involving in an accident.

The damage incurred is = $1990

There is 90% chance that nothing will happen'

Utility function U (1) √1

Now,

We find the fair price of this policy

A fair premium is the amount that enables insurance company to break exactly even. that is to say

economic zero profit = expected costs.

Thus,

EC = p * (The loss of income if the accidents take place) + 1 - p (The income loss when accidents foes not take place)

EC = 0.1 ($1990) + 0.9 (0) =

EC = $199 + 0 = $199

Therefore, the fair price of this policy is $199