Jeff is a risk-neutral middle-aged American. The data on his computer is worth $

Question

Jeff is a risk-neutral middle-aged American. The data on his computer is worth $2000. If his computer gets a virus, he will have to spend $600 to restore the data. Alternatively, he can purchase Norton Antivirus for $100.

a. If he believes there is a 50% chance that he will get a virus, should he buy the antivirus software?

b. Jeff’s neighbor is a psychic who specializes in knowing what will happen to computers. How much is Jeff willing to pay his neighbor to know if he will get a virus, if his neighbor is always correct?

c. How would your answer to part b change if his neighbor is only correct 90% of the time?

Explanation / Answer

Given that the value of the data is $2000, Loss in case of virus is $600, price of anti virus is $100 and probability of virus is .5.

Problem a:

Expected loss is .5*600+.5*0=$300. Now if he invest in antivirus $100 which is less then the excpected loss, he would save $200. So he should buy the antivirus.

Problem b:

Let assume that the total wealth, Jeff is having is $2000.

After the loss total wealth become $1400 and if he purchase the advise from his neighbor for say $x then,

Expected value of wealth is : 2000*.5+1400*.5=1700

So price of advice become 2000-1700=$300, jeff is willing to pay $300.

Problem C:

Now if his neighbor is correct with .9 probability:

So, 300*.9 - 600*.1 = $210.

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