Problem
Initially, Maria consumes 400 kg of food when it's sunny and 75 kg of food when there's a hurricane (due to property losses from flooding). Her indifference curves are L-shaped, as in exercise 11.4. Suppose that flood insurance is available, and that the premium, M, for each dollar of promised benefit is less than a dollar (but greater than zero). Solve for Maria's best choice as a function of M. How much insurance will she buy, and how much food will she consume? (Hint: Draw a graph. Does she partially insure or fully insure?) Does your answer depend on the probability of a hurricane? Explain.
Exercise 11.4
Suppose that consumption when it's sunny and consumption when there's a hurricane are perfect complements. The investor's indifference curves are L-shaped, and the corner of each L lies on the 45-degree line. Using graphs, explain why these assumptions imply infinite risk aversion.
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.