Answered: Tom wants to avoid any accidents on the…

Managerial Economics: A Problem Solving Approach

5th Edition

ISBN:9781337106665

Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Chapter20: The Problem Of Adverse Selection Moral Hazard

Section: Chapter Questions

Problem 3MC

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Question

Tom wants to avoid any accidents on the work floor of his factory. If an accident does occur, it
would cost him $500,000 in damages. Installing safety equipment would decrease the probability
of an accident occurring from 20% to 10%. However, the equipment costs $20,000 to install.
10. What is his expected loss after installing the safety equipment
a. $20,000
b. $50,000
c. $100,000
d. $125,000

Expert Solution

Step 1

Introduction:

Expected Loss: the expected loss is the expected loss which is pre-decided that, it will occur in near future.

Given;

Cost of damages= $500000

The initial probability of accident= 20%

Decrease in occurring= 10%

Equipment cost= $20000

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