Megan is trying to decide whether to buy house insurance for her home in Miami. Her house is worth $200,000 and analysts have determined that the average loss from a Hurricane could be $45,000. They have also determined there is a 50 percent chance that she will face a hurricane. Suppose Megan is a risk averse person with a utility-of-income function such as the one given below. If the policy costs $22,500, Megan will

Question

Quizplus · Accepted Answer

Megan's expected utility without insurance is:
U(155000) = ln(155000) = 11.95

Her expected utility with insurance is:
0.5U(200000 - 45000 - 22500) + 0.5U(200000 - 22500 - 22500 - 22500) = 
0.5ln(132500) + 0.5ln(155000) = 11.64

Thus, Megan would be better off buying the insurance as it increases her expected utility from 11.95 to 11.64. Therefore, the best choice for Megan is to buy the insurance (Choice A).

Megan Is Trying to Decide Whether to Buy House Insurance