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: state 1, in which their cars need no repairs and their income available for purchasing other goods and services is equal to $50,000; and state 2, in which 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) Refer to the information in the scenario Choosing Insurance.The Ramirez family can buy insurance that will cover the full cost of repairs for $900.If family members are risk-averse and maximize their expected utility:
A)they will buy the insurance.
B)they will be indifferent between buying and not buying the insurance, since their expected income for purchasing other goods and services is $49,000, regardless of what they do.
C)they will not buy the insurance, since buying it does not increase their expected income for purchasing other goods and services.
D)they will self-insure.

Question

Quizplus · Accepted Answer

The Ramirez family is risk-averse, meaning they prefer to avoid risk when possible. Buying the insurance for $900 ensures that they will not have to bear the risk of incurring the $10,000 cost of repairs in state 2, which has a 10% chance of occurring. Therefore, their expected utility will be higher if they purchase the insurance, as it reduces their overall risk.

Scenario: Choosing Insurance the Ramirez Family Owns Three Cars and Is