You live in an area that has a possibility of incurring a massive earthquake, so you are considering buying earthquake insurance on your home at an annual cost of $180. The probability of an earthquake damaging your home during one year is 0.001. If this happens, you estimate that the cost of the damage (fully covered by earthquake insurance) will be $160,000. Your total assets (including your home) are worth $250,000.

You live in an area that has a possibility of incurring a massive earthquake, so you are considering buying earthquake insurance on your home at an annual cost of $180. The probability of an earthquake damaging your home during one year is 0.001. If this happens, you estimate that the cost of the damage (fully covered by earthquake insurance) will be $160,000. Your total assets (including your home) are worth $250,000.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.1P

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Utility Theory You live in an area that has a possibility of incurring a massive earthquake, so you are considering buyingearthquake insurance on your home at an annual cost of $180. The probability of an earthquake damagingyour home during one year is 0.001. If this happens, you estimate that the cost of the damage (fully coveredby earthquake insurance) will be $160,000. Your total assets (including your home) are worth $250,000. A. Apply Bayes’ decision rule to determine which alternative (take the insurance or not) maximizes yourexpected assets after one year.
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