Homework Help: Economics

Posted by Susan on Saturday, December 5, 2009 at 6:40am.

3. Peter owns just his car and has Ł2,500 in cash. The car is worth Ł7,500. The probability that the car will be stolen (and never recovered) is 0.1. If his vNM utility function is two times the square root of his wealth, what is the maximum amount he would pay for a full-coverage insurance on his car?

(A) Ł975.
(B) Ł199.
(C) Ł1000.
(D) Ł900.
(E) Ł1164.

(Solution is A, 975)

Economics - economyst, Saturday, December 5, 2009 at 2:37pm
Without insurance, Pete's expected utility is .9*sqrt(2*10000) + .1*sqrt(2*2500) = 134.3502884 utils So, what wealth give him equal amount of utility. Well, work the utility formula backwards. That is (134.3502884^2)/2 = 9025. Take it from here.

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