Question 4: Option Price Calculation (35 points) (a)(5 pts) Define option price. Explain why the option price of a policy might differ from the expected surplus generated by the policy. (b)(5 pts) Define option value. Suppose that a public project is increasing the risk faced by farmers, but the expected income of each farmer does not depend on whether the project is undertaken or not. Let farmer A be risk averse and farmer B be risk neutral. Compare their option values. Now consider the following project: Construction of a Dam. The only person affected by this project is a farmer, with utility U(I) where $I is his income. There are two possible contingencies: it rains a lot (Wet) or it does not rain a lot (Dry). With the Dam, his income is $1000 if Wet and $900 if Dry. Without the Dam, his income is $500 if Wet and $300 if Dry. The probability of raining a lot is 50%. (c)(5 pts) What is the expected surplus of the farmer