10. Bob must ship his belongings worth 1,000 to England from Latin America. The prob- ability that a ship sinks and he loses the entire value of his shipment is 0.1. Assume that if one ship sinks it does not affect the probability that the second ship sinks. He has the option of shipping everything in one single container or shipping his belong- ings separately on two different ships.
(a) [15 marks] If the shippers will transport Bob’s goods for the same price either separately or on the same ship, which method of shipment will he choose ac- cording to whether he is risk averse, risk loving or risk neutral? In your answer define and explain the concepts of risk aversion, risk loving and risk neutrality.
(b) [10 marks] Let Bob have utility U(X) = X for X 1,000 and U(X) = 500 + (X/2) for X > 1,000, where X is the value of the goods. Is Bob risk averse, risk neutral or risk loving? How much more would he be willing to pay for his preferred form of shipment?
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