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Scenario: Choosing Insurance
The Ramirez family owns three cars and is considering buying insurance to cover the cost of repairs.They face two possible states: in state 1,their cars need no repairs and their income available for purchasing other goods and services is $50 000;in state 2,their cars need $10 000 worth of repairs and their income available for purchasing other goods and services is reduced to $40 000.The probability of repairs is 10%,while the probability of no repairs is 90%.
-(Scenario: Choosing Insurance)Use Scenario: Choosing Insurance.The premium on a fair insurance policy for the Ramirez family will be:
A) $0.
B) $900.
C) $1 000.
D) $2 000.

Question

Quizplus · Accepted Answer

To determine the fair premium for an insurance policy, we need to calculate the expected value of the cost of repairs.

The expected value is calculated as follows:

Expected value = probability of state 1 * cost of state 1 + probability of state 2 * cost of state 2

Expected value = (0.9 * $0) + (0.1 * $10 000)

Expected value = $1 000

Therefore, the fair premium for an insurance policy would be $1 000. This is the amount the Ramirez family should expect to pay, on average, to cover the cost of repairs for their three cars.

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