Teddy is considering buying flood insurance. The cost of flood insurance is $400 per year. Teddy predicts that there is a 20% chance that his house will flood and estimates that a flood will cause $1,000 in damages. If he gets insurance and there's no flood damage, he will lose his $400. However, if he gets insurance and there is flood damage, the insurance company will pay $1,000 for the damages. Since Teddy only paid $400 for the insurance, he will essentially save himself $600. What is the expected value of savings/losses for Teddy buying insurance?
(1 point)
Responses
negative 200 dollars
Image with alt text: negative 200 dollars
$600
$600
negative 400 dollars
Image with alt text: negative 400 dollars
$120
The expected value of savings/losses for Teddy buying insurance can be calculated by considering the probability of each outcome.
If there is no flood damage:
Probability = 80%
Savings = -$400
If there is flood damage:
Probability = 20%
Savings = $600
Expected value = (0.8 x -400) + (0.2 x 600)
Expected value = -320 + 120
Expected value = -$200
Therefore, the expected value of savings/losses for Teddy buying insurance is negative $200.