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IAI Actuarial Core Principles · Business Economics · Relationship between economics and business

A Pune motor insurer sells 40,000 policies a year at a premium of Rs 10,000. Selling the 40,001st policy would add Rs 10,000 to revenue and Rs 12,500 to cost. Assuming profit maximisation, what should the insurer do at the margin?

The insurer should not sell the extra policy because its marginal cost of Rs 12,500 exceeds its marginal revenue of Rs 10,000, cutting profit by Rs 2,500. A profit maximiser expands output only while marginal revenue is at least marginal cost.

  1. ASell it, because average revenue exceeds zero
  2. BSell it, because revenue rises
  3. CNot sell it, because marginal cost exceeds marginal revenueCorrect
  4. DNot sell it, because average cost is rising
  5. Sell it, because total cost is already sunk

Explanation

Marginal revenue is Rs 10,000 and marginal cost is Rs 12,500, so the extra policy reduces profit by Rs 2,500. A profit maximiser expands output only while MR is at least MC, so it should not sell it. Revenue rising alone is not sufficient.

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