Business, 21.04.2020 04:18 JaylahtheSmarrtie

Willy’s only source of wealth is his chocolate factory. He has the utility function p(cf)1/2 + (1 − p)(cnf)1/2,where p is the probability of a flood, 1 − p is the probability of no flood, and cf and cnf are his wealth contingent on a flood and on no flood, respectively. The probability of a flood is p = 1/6. The value of Willy’s factory is $500,000 if there is no flood and $0 if there is a flood. Willy can buy insurance where if he buys $x worth of insurance, he must pay the insurance company $2x/17 whether there is a flood or not but he gets back $x from the company if there is a flood. Willy should buy:

a) no insurance since the cost per dollar of insurance exceeds the probability of a flood
b) enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/4 of what it would be if there were no flood
c) enough insurance so that if there is a flood, after he collects his insurance, his wealth will be the same whether there was a flood or not
d) enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/3 of what it would be if there were no flood
e) enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/5 of what it would be if there were no flood

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