are sunflower farmers in the village of Gold. They each have zero
wealth, so their consumption is equal to the income they earn from
their economic activity. Each of them must choose one (and only
one) of the following three activities: Activity 1: Full time
farming. Sunflower farming is risky because of a combination of
weather and pests. Under full time farming, the farmer works 7 days
per week on their farm. There is a 50% probability of having a GOOD
harvest and a 50% chance of having a BAD harvest. If the harvest is
GOOD, the farmer earns an income of $200. If the harvest is BAD,
the farmer earns an income of only $40. Activity 2: Full time
construction work. This activity has no risk. An individual who
decides to work full time in construction earns $80 with certainty.
Activity 3: Part-time farming. In this third activity, the farmer
works during the week as a sunflower farmer and works in
construction during the weekend. Since she is not able to work full
time on the farm, the probability of having a GOOD harvest and
earning $200 drops to 25%, and the probability of having a BAD
harvest and earning only $40 increases to 75%. The individual also
earns $30 with certainty as a construction worker (the person earns
this $30 from construction in addition to her farm income under
both a GOOD and BAD harvest).
- Problem 3 Risk Preferences And Insurance Steve Clark And Drew Are Sunflower Farmers In The Village Of Gold They Each 1 (7.65 KiB) Viewed 28 times
insurance contracts only to full time farmers. He is not interested
in offering insurance to part time farmers. The contracts are
straightforward. At the beginning of the season, farmers pay a
premium of $50. At the end of the season, Jordan pays farmers an
indemnity payment of $100 if the farmer had a BAD harvest. If the
farmer had a GOOD harvest, Jordan doesn’t pay the farmer anything.
For questions e-f, assume that Jordan has perfect information about
the farmer’s activity choice. In other words, he can write and
enforce a contract that requires the farmer to choose full time
farming.
(e)What is Jordan’s expected profit from this contract? (Jordan’s
profit is just the premium he collectsfrom the farmer minus the
indemnity payment he makes to the farmer).
(f)What is the expected consumption for an individual who
chooses full-time farming withJordan’s insurance contract?
Steve: U(C) = 0.05C² Clark: U(C) = 25C -0.05C² Drew: U(C) = 0.5C