(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.

Question

Manasvi Sharma · Accepted Answer

Final Answer : A, Explanation :  If the Ramirez family buys the insurance for $1,000, they will be fully covered in the event that their cars need repairs, which has a 10% probability. This means that in state 2, their income available for purchasing goods and services will not be reduced by $10,000, but will remain at $50,000. Therefore, buying the insurance will maximize their expected utility.

Definitions

Learning Objectives

Learning Objectives

Related questions