Suppose that consumers have utility function U(C) = log(C) where C is the con- sumption level and log is the natural logarithm. Consumers have initial consumption levels of 100 and are exposed to the following risk of loss: lose 10 with probability 0.4 and lose 5 with probability 0.6. They are considering buying insurance to cover these losses.
(a) What is the fair price for the insurance?
(b) What is the certainty equivalent level of C when uninsured? (Hint: Find the consumption level CE such that U (CE) equals the expected utility when uninsured.)