a) Should the household buy this insurance policy? Explain briefly. b) Should it
ID: 1181212 • Letter: A
Question
a) Should the household buy this insurance policy? Explain briefly.
b) Should it buy the insurance policy if it costs $1,500? $3,000? Explain briefly.
c) What is the most the household is willing to pay for this insurance policy?
Consider a household that possesses $100,000 worth of values (computers, electronics, jewelry, etc). This household faces a 0.10 probability of a burglary. If a burglary were to occur, the household would have to spend $20,000 to replace the stolen items. Suppose it can buy an insurance policy for $500 that would fully reimburse it for the amount of the loss. Should the household buy this insurance policy? Explain briefly. Should it buy the insurance policy if it costs $1,500? $3,000? Explain briefly. What is the most the household is willing to pay for this insurance policy?Explanation / Answer
a) Payoff for each household if insurance is not bought= 90%*0 + 10%*20000 =$2000
Payoff for each househld if insurance is bought = 500 +90%*0 + 10%*100 = $500
Since household incur les cost if insurance is bought is bought, therefore the household should buy this insurance policy
b) If insurance policy costs $1,500, then household should buy this insurance policy because household will incur more cost ($2000>$1500) if the policy is not bought
If insurance policy costs $3000, then household should NOT buy this insurance policy because household will incur less cost ($3000>$2000) if the policy is not bought
c. the most the household is willing to pay for this insurance policy =$2000
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