Consider a risk averse agent. He faces a health risk of D(he/she has to go to the hospital and pay D, and he/she will be fine) with probability k. He/she can buy insurance at price q (that is he/she can buy at cost q a contract that pays 1 dollar if he/she has to go to the hospital). How many units of the contract will the agent buy if the price is q=k?© BrainMass Inc. brainmass.com November 24, 2022, 11:53 am ad1c9bdddf
If she buys n units of insurance, the utility is
Ui = U(n*1 - nq -D)*k + U(-nq)*(1-k) = ...
The solution applies utility function and summarizes risk aversion.