(Scenario: Deciding on Insurance Type under Uncertainty) Use Scenario: Deciding on Insurance Type under Uncertainty. For $900, the Garcia family can buy insurance that will cover the full cost of accidents. If family members are risk averse and maximize their expected utility, they will:
Scenario: Deciding on Insurance Type under Uncertainty
The Garcia family owns three cars and is considering buying insurance to cover the cost of repairs made necessary by accidents. They face two possible states: state 1, in which their cars require no repairs, and their income available for purchasing other goods and services is $50,000; and state 2, in which their cars require $10,000 worth of repairs, and their income available for purchasing other goods and services is reduced to $40,000. The probability that their cars will require repairs is 10%; the probability that they will not is 90%.

Question

Quizplus · Accepted Answer

The Garcia family is risk averse and will want to maximize their expected utility. Given the probabilities and costs of the two states, the expected cost of repairs without insurance is $1,000 ($10,000 x 10%) and the expected income available for purchasing other goods and services is $49,100 (($50,000 x 90%) + ($40,000 x 10%)). With insurance, the total cost is $900, regardless of whether repairs are needed or not, and the expected income available for purchasing other goods and services is still $49,100. Therefore, buying insurance will reduce their expected cost and help them maximize their expected utility.

(Scenario: Deciding on Insurance Type Under Uncertainty) Use Scenario: Deciding