Question

You are a relatively safe driver. The probability that you will have an accident is only 1 percent. If you do have an accident, the cost of repairs and alternative transportation would reduce your disposable income from $120,000 to $60,000. Auto collision insurance that will fully insure you against your loss is being sold at a price of $0.10 for every $1 of coverage. You are considering two alternatives: buying a policy with a $1,000 deductible that essentially provides just $59,000 worth of coverage, or buying a policy that fully insures you against damage. The price of the first policy is $5,900. The price of the second policy is $6,000. Which policy do you prefer?

Answer 1

Answer:-

=> expected utility if you buy the first policy is :-

U = √I

= 0.01 √ (120000-60000+59000-5900 )+ 0.99√ (120000-5900)

= 0.01√ (113100) + 0.99√(114100)

= 3.363 + 334.409

= 377.77

=> you buy the second policy, your expected utility :-

U= √I

= 0.01√(120000-60000+ 60000-6000) + √(120000-6000)

= 0.01√114000 + 0.99√114000

= 3.376 + 334.26

= 337.64

we should prefer first insurance policy as it's utility is maximum.