Suppose an individual has the following utility function defined over wealth: U = U(√wealth). The individual has an initial wealth level of $20,000.
A new drug has been developed that is effective in preventing heart attacks. Taking the drug reduces the chance of a heart attack to 10%, but the loss associated with the attack increases to $10,000.
a) What is the expected loss?
b) What is the maximum amount this individual is willing to pay for insurance against a heart attack?
c) What is the risk premium?