-Jennifer has the utility of wealth curve shown in the figure above. She owns a car worth $15,000, and that is her only wealth. There is a 10 percent chance that Jennifer will have an accident within a year. If she does have an accident, her car is worthless. The maximum amount that Jennifer is willing to pay for auto insurance is
A) $3,500.
B) $2,000.
C) $4,500.
D) $9,000.

Question

-Jennifer has the utility of wealth curve shown in the figure above. She owns a car worth $15,000, and that is her only wealth. There is a 10 percent chance that Jennifer will have an accident within a year. If she does have an accident, her car is worthless. The maximum amount that Jennifer is willing to pay for auto insurance is
A) $3,500. 
B) $2,000. 
C) $4,500. 
D) $9,000.

Quizplus · Accepted Answer

Jennifer's expected loss from an accident is $1,500 (10% of $15,000). However, due to risk aversion, she is willing to pay more than the expected loss to avoid the risk. The maximum amount she is willing to pay is the difference between her current wealth and the certainty equivalent wealth, which is $4,500.

-Jennifer Has the Utility of Wealth Curve Shown in the Figure