Mel is thinking of going on a cruise. Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50. The probability of nice weather is 60 percent and the probability of bad weather is 40 percent. Trip insurance is sometimes available. If purchased, it allows travelers to delay the cruise until the weather is nice. If Mel is risk-neutral, then in the absence of trip insurance, the most she will be willing to pay for the cruise is:
A)$1,200.
B)$1,250.
C)$1,220.
D)$1,000.

Question

Mel is thinking of going on a cruise. Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50. The probability of nice weather is 60 percent and the probability of bad weather is 40 percent. Trip insurance is sometimes available. If purchased, it allows travelers to delay the cruise until the weather is nice. If Mel is risk-neutral, then in the absence of trip insurance, the most she will be willing to pay for the cruise is:
A)$1,200.
B)$1,250.
C)$1,220.
D)$1,000.

Quizplus · Accepted Answer

The expected benefit of going on the cruise is $1,220 = (0.60)($2,000)+ (0.40)($50). Because Mel is risk-neutral, she will only take gambles in which the expected value is greater than or equal to 0, so he would never pay more than the expected benefit of $1,220.

Mel Is Thinking of Going on a Cruise