Consider Sunny who is committed to a life of crime. Sunny is risk averse, knows that he will enjoy..

Consider Sunny who is committed to a life of crime. Sunny is risk averse, knows that he will enjoy consumption level x1 if he does not get caught and consumption level of x0 (very much below x1) if he gets caught and goes to jail. He estimates the probability of getting caught as δ. A. Suppose there are various mafia organizations that have connections in the District Attorney’s office and can affect the outcomes of court cases. Suppose initially that Sunny’s tastes are state independent. (a) First, consider a really powerful mafia that can insure that any of its members who is caught is immediately released. Can you illustrate how much such a mafia would be able to charge Sunny if Sunny is risk averse? What about if Sunny is risk loving? (b) Next, suppose that the local mafia is not quite as powerful and can only get jail sentences reduced— thus in effect raising x0. It approaches Sunny to offer him a deal: Pay us p when you don’t get caught, and we’ll raise your consumption level if you do get caught by b. If the local mafia insurance business is perfectly competitive (and faces no costs other than paying for increased consumption in jail), what is the relationship between b and p? (Hint: Note that this is different than the insurance example in the text where my wife had to pay p regardless of whether she was in the good or bad outcome.) (c) Suppose that Sunny can choose any combination of b and p that satisfies the relationship you derived in (b). What would h

 

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