Question

Suppose you face a choice between a certain income of $2,000, or a 50-50 chance of income of $1,000 or $3,000. Suppose you prefer the certain $2,000. You are risk averse.
a. True
b. False

Suppose that a disease affects 5% of the population and that everyone is equally likely to get the disease. Treatment for this disease costs $38,000. Assume that this disease, and necessary treatment, represent the only healthcare costs in this population. The expected cost of healthcare is $_________. If people___________ to pay the expected cost of healthcare with certainty, rather than take on the 5% risk of having to pay the full cost of the treatment, they are risk averse.

Answer 1

Solution :

The risk averse is the person who wishes to reduce the uncertainty attached to the money.

Certain income = $2000.

50-50 chance of 1000 and 3000 would income expected income of

(0.5 x 1000) +(0.5 x 3000) = 2000

Both of them gives an equal amount of income while there is uncertainty attached with the second case which makes the risk averse person disincline to follow.

Hence the statement is FALSE.

Assume that the population level in a country is X. 5 percent of the population are likely to get affected by the disease due to which it makes a population of 0.05 X population to be effected by the disease. The population level will cost  $38,000, hence making the total healthcare cost to be 1900 X.