Suppose a homeowner who has a house worth £250,000 faces a 5% chance of a flood in any given year, in which case, she suffers damages reducing the value of the house by £20,000. (a) Assuming that the homeowner possesses a utility function of the form U(Cs) = C32, = c,, where s denotes state of nature and the insurance company offers insurance at the fair rate, show that the amount of insurance the individual will purchase is equal to £20,000 in any given year. (b) What is the homeowner's expected utility at this rate of insurance?

Suppose a homeowner who has a house worth £250,000 faces a 5% chance of a flood in any given year, in which case, she suffers damages reducing the value of the house by £20,000. (a) Assuming that the homeowner possesses a utility function of the form U(Cs) = C32, = c,, where s denotes state of nature and the insurance company offers insurance at the fair rate, show that the amount of insurance the individual will purchase is equal to £20,000 in any given year. (b) What is the homeowner's expected utility at this rate of insurance?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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