In Eugene, Oregon, next year there is a 2% chance of an earthquake severe enough to destroy all buildings and personal property. Quincy, who has $3,000,000 in buildings and personal property, has the opportunity to purchase complete earthquake insurance. Which is true?
A) Quincy should not purchase earthquake insurance unless he can get it for less than $60,000, because that's all he could possibly lose in an earthquake.
B) Quincy should not purchase earthquake insurance unless he can get it for less than $60,000, because that's his expected loss in an earthquake.
C) If Quincy buys earthquake insurance, and an earthquake does not occur, he will have received no utility from the transaction.
D) What Quincy is willing to pay for the earthquake insurance depends upon his degree of risk aversion.
E) Quincy should be willing and able to pay up to $3,000,000 for earthquake insurance.

Question

Quizplus · Accepted Answer

Quincy's willingness to pay for earthquake insurance depends on how risk-averse he is. If he is very risk-averse, he may be willing to pay a high premium to ensure that he will not suffer a catastrophic loss in the event of an earthquake. On the other hand, if he is less risk-averse, he may decide that the cost of the insurance is not worth the small probability of a complete loss. Therefore, the best choice is D.

In Eugene, Oregon, Next Year There Is a 2% Chance