You live in an area that has a possibility of incurring a massive earthquake, so you are considering buying earthquake insurance on your home at an annual cost of $180. The probability of an earthquake damaging your home during one year is 0.001. If this happens, you estimate that the cost of the damage (fully covered by earthquake insurance) will be $160,000. Your total assets (including your home) are worth $250,000.
You live in an area that has a possibility of incurring a massive earthquake, so you are considering buying earthquake insurance on your home at an annual cost of $180. The probability of an earthquake damaging your home during one year is 0.001. If this happens, you estimate that the cost of the damage (fully covered by earthquake insurance) will be $160,000. Your total assets (including your home) are worth $250,000.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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You live in an area that has a possibility of incurring a massive earthquake, so you are considering buying
earthquake insurance on your home at an annual cost of $180. The probability of an earthquake damaging
your home during one year is 0.001. If this happens, you estimate that the cost of the damage (fully covered
by earthquake insurance) will be $160,000. Your total assets (including your home) are worth $250,000.
Transcribed Image Text:You now have constructed a utility function that measures how much you value having
total assets worth x dollars (x ≥ 0). This utility function is U(X)=√x. Compare the utility of
reducing your total assets next year by the cost of the earthquake insurance with the
expected utility next year of not taking the earthquake insurance. Should you take the
insurance?
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