-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. The value of insurance to Andrew against an accident is
A) zero.
B) $3,000 per year.
C) $10,000 per year.
D) $6,000 per year.

Question

-Andrew has the utility of wealth curve shown in the above figure. He owns an SUV worth $30,000, and that is his only wealth. There is a 10 percent chance that he will have an accident within a year. If he does have an accident, his SUV is worthless. The value of insurance to Andrew against an accident is
A) zero. 
B) $3,000 per year. 
C) $10,000 per year. 
D) $6,000 per year.

Quizplus · Accepted Answer

The value of insurance is the difference between the expected utility without insurance and the utility with insurance. Given the 10% chance of losing $30,000, the expected loss is $3,000. However, due to risk aversion, the utility loss is greater than the monetary loss, making the value of insurance higher than $3,000. The value of $6,000 accounts for this risk aversion.

-Andrew Has the Utility of Wealth Curve Shown in the Above