Asked by Joycelyn Acheampong on Jun 12, 2024
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(Scenario: Choosing Insurance) Use Scenario: Choosing Insurance.For $1,000,the Ramirez family can buy insurance that will cover the full cost of repairs.If family members are risk-averse and want to maximize their expected utility,they will: Scenario: Choosing Insurance
The Ramirez family owns three cars and is considering buying insurance to cover the cost of repairs.They face two possible states: in state 1,their cars need no repairs and their income available for purchasing other goods and services is $50,000;in state 2,their cars need $10,000 worth of repairs and their income available for purchasing other goods and services is reduced to $40,000.The probability of repairs is 10%,while the probability of no repairs is 90%.
A) buy the insurance.
B) be indifferent between buying and not buying the insurance since their expected income for purchasing other goods and services is $49,000,regardless of what they do.
C) buy the insurance as long as the utility of having a certain income of $48,000 to buy goods and services other than car repairs is higher than the utility associated with their expected income without insurance.
D) self-insure.
Expected Utility
A theory in economics that explains how people make decisions under uncertainty, based on the anticipated satisfaction or utility from outcomes.
Risk-averse
A description of an individual or entity that prefers to avoid risk, often opting for the less risky of available options.
Probability
A measure of the likelihood or chance that a particular event will occur, expressed as a number between 0 and 1.
- Examine the advantages associated with purchasing insurance according to expected utility theory.
- Discover the processes by which insurance allocates risk and its repercussions on future utility expectations.
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Learning Objectives
- Examine the advantages associated with purchasing insurance according to expected utility theory.
- Discover the processes by which insurance allocates risk and its repercussions on future utility expectations.
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