Mel is thinking of going on a cruise.Mel values a cruise in nice weather at $2,000 and values a cruise in bad weather at $50.According to a very reliable source,the probability of nice weather is 60% and the probability of bad weather is 40%.Trip insurance is sometimes available.If purchased,it allows travelers to delay the cruise until the weather is nice.
Suppose that the price of the cruise is $1200.If Mel is not risk averse,Mel should buy trip insurance

Question

Quizplus · Accepted Answer

The expected value of the cruise without insurance is 0.6 * $2000 + 0.4 * $50 = $1220. The maximum Mel should pay for insurance is the difference between this expected value and the cruise price, which is $1220 - $1200 = $20. However, since insurance allows Mel to ensure nice weather, the value of the cruise becomes $2000, so Mel should be willing to pay up to $2000 - $1220 = $780 for the insurance.

Mel Is Thinking of Going on a Cruise