Suppose people cannot tell for sure whether they will fall ill in any given year. High-risk people correctly perceive their chance of falling ill in a year is 30 percent, and low-risk people correctly perceive that their chance of falling ill is 10 percent. Both high-risk and low-risk people have to pay $10,000 in medical expenses if they fall ill, and nothing if they remain healthy. a. What are the expected annual medical expenses of a high-risk person?
b. What are the expected annual medical expenses of a low-risk person?
c. Suppose insurance companies cannot tell whether someone is high-risk or low-risk. They only know that half of all people are high-risk, and half of all people are low-risk. So, they offer a health insurance policy that costs $2,000 per year in exchange for covering all of a person's medical expenses should they fall ill. If high-risk people, and low-risk people are risk-neutral, then who will purchase this insurance policy? Will the insurance company be able to stay in business if it continues to charge $2,000 per year? Briefly explain.