Question

In: Economics

Suppose an individual is looking to build a house in a plain that is prone to...

Suppose an individual is looking to build a house in a plain that is prone to flooding. Because of the risk of damage due to flooding, the buyer's top dollar for building the house is only $280,000. Suppose the cost of building a house in this area is $320,000. A wealth-creating transaction is not possible since the seller's bottom line (or the cost of building the house) is greater than the buyer's top dollar. The difference between the cost of building the house minus the buyer's top dollar is $40,000.00 .

Suppose the government subsidizes flood insurance for homes in the flood plain. Because of this, the buyer has access to very cheap insurance, worth an expected $70,000. Without such a subsidy, the high likelihood of flood results in extremely high rates for flood insurance. With this subsidy, the individual IS OR IS NOT incentivized to build a house in the flood plain.

Solutions

Expert Solution

The individual is incentivized to build the house due to the subsidy.
It will be so if the buyer's top dollar of building and insurance after subsidy is greater than the cost of building. This effectively reduces the insurance cost to the buyer.

Rahul Sunny answered 2 years ago
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