Willingness to overpay for insurance and for consumer credit: search and risk behavior under price dispersion

Malakhov, Sergey (2014): Willingness to overpay for insurance and for consumer credit: search and risk behavior under price dispersion. Published in: Expert Journal of Economics , Vol. 2, No. 3 (2014): pp. 109-119.

Abstract

When income growth under price dispersion reduces the time of search and raises prices of purchases, the increase in purchase price can be presented as the increase in the willingness to pay for insurance or the willingness to pay for consumer credit. The optimal consumer decision represents the trade-off between the propensity to search for beneficial insurance or consumer credit, and marginal savings on insurance policy or consumer credit. Under price dispersion the indirect utility function takes the form of cubic parabola, where the risk aversion behavior ends at the saddle point of the comprehensive insurance or the complete consumer credit. The comparative static analysis of the saddle point of the utility function discovers the ambiguity of the departure from risk-neutrality. This ambiguity can produce the ordinary risk seeking behavior as well as mathematical catastrophes of Veblen-effect’s imprudence and over prudence of family altruism. The comeback to risk aversion is also ambiguous and it results either in increasing or in decreasing relative risk aversion. The paper argues that the decreasing relative risk aversion comes to the optimum quantity of money.

• Item Type: MPRA Paper
• Language: English
• Keywords: consumer search, risk, insurance, credit, optimum quantity of money, Veblen effect, family altruism, mathematical catastrophe
• Subjects: D - Microeconomics > D1 - Household Behavior and Family Economics > D11 - Consumer Economics: Theory; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty

References

1. Becker G.S. (1981) ‘Altruism in the Family and Selfishness in the Market Place’, Economica, New Series, 48 (189), 1-15.

2. Bewley, T. (1983). ‘A Difficulty with the Optimum Quantity of Money’, Econometrica, 51, 5, 1485-1504.

3. Diamond, P. (1971). ‘A Model of Price Adjustment’, Journal of Economic Theory, 3, 156-168.

4. Ehrlich, I. and Becker, G.S. (1972). ‘Market Insurance, Self-Insurance and Self-Protection’ Journal of Political Economy. 80(4), 623-648.

5. Feenstra, R. (1986). “Functional equivalence between Liquidity Costs and the Utility of Money’, Journal of Monetary Economics, 17, 271-291.

6. Friedman, M., Savage, L.J. (1948). ‘The Utility Analysis of Choices Involving Risk’, Journal of Political Economy, 56, 279-304.

7. Friedman, M. (2005 [1969]) ‘The optimum quantity of money’ Transaction Publishers.

8. Guariglia, A. Rossi, M. (2004). ‘Private medical insurance and saving: evidence from the British Household Panel Survey’ Journal of Health Economics. 23, 761-783.

9. Hubbard, R.G., Skinner, J., Zelders, P. (1995) ‘Precautionary Saving and Social Insurance’ Journal of Political Economy. 103(2), 360-99.

10. Kahneman, D., Tversky,А. (1979) ‘Prospect Theory: An Analysis of Decision under Risk’, Econometrica, XVLII (1979), 263—291.

11. Mehrling, P. (1995). ‘A Note on the Optimum Quantity of Money’, Journal of Mathematical Economics, 24, 249-258.

12. Malakhov, S. (2013). ‘Money Flexibility and Optimal Consumption-Leisure Choice’ Theoretical and Practical Research in Economic Fields, IV (1), 77-88. (http://www.asers.eu/asers_files/tpref/TPREF%20Volume%20IV%20Issue%201_7_%20Summer%202013_last.pdf)

13. Malakhov, S. (2014) ‘Satisficing Decision Procedure and Optimal Consumption-Leisure Choice.’ International Journal of Social Science Research, 2 (2), 138-151(http://dx.doi.org/10.5296/ijssr.v2i2.6158)

14. Marshall, A. (1920 [1890] 'Principles of Economics. An Introductory Volume.' London: Macmillan and Co., Ltd.

15. Stigler, J. (1961).‘The Economics of Information.’ Journal of Political Economy, 69(3), 213-225.

16. Whalen, E. (1966). ‘A Rationalization for the Precautionary Demand for Cash’, Quarterly Journal of Economics, 80 (2), 314-324.