Question

Suppose that you work for Gecko Car Insurance and are tasked with pricing decisions. Suppose that there are 10 bad drivers in the market who all have a 49% chance of filing a claim, 20 good drivers who all have a 12% chance of filing a claim, and 20 excellent drivers who all have a 1% chance of filing a claim. To simplify, assume that any time an accident occurs, Gecko must pay $1000 to insured drivers. Drivers without insurance face the same cost if they do not have insurance. Assume all drivers are risk neutral and that insurance costs $200. At this price, which drivers choose to buy car insurance? O bad drivers good drivers excellent drivers If the above description includes all revenue and costs, what is Gecko's expected profit? Expected profit: $ To earn positive expected profit, what is the minimum amount Gecko must charge for insurance? $200 O $201 O $490 O $491 O $4901 O There is no price at which Gecko will earn a positive profit.

Answer 1

Expected cost in case of bad drivers=1000*49%=$490

Expected cost in case of good drivers=1000*12%=$120

Expected cost in case of excellent drivers=1000*1%=$10

In case of insurance cost is $200, drives who have expected cost of higher than $200, will buy the insurance. So, bad drives will buy insurance in this case.

Correct option is

bad drivers

Total Revenue=TR=10*200=$2000

Expected Cost=TC=10*490=$4900

Expected profit=TR-TC=2000-4900=-$2900

Since, all drivers are risk neutral, no one will pay higher than the expected cost. So, there is no chance of positive profit in this case.

Correct option is

There is no price at which Gecko will earn a positive profit.