Continuing with the same family from the preceding question,suppose a risk neutral insurance company exists to provide vacation insurance.Suppose further that each vacation day requires a constant expenditure,and this expenditure is standard across everybody. This allows us to simplify the problem by considering all payments to be in terms of vacation days. What is the least the insurance company would charge (in terms of vacation days)?
A)1
B)2
C)3
D)4

Question

Quizplus · Accepted Answer

Since the family has a 25% chance of losing their vacation due to illness, they would need to budget for an additional 2 days of vacation (1/0.25 = 4 days total budgeted vacation). Therefore, the insurance company would only need to charge 2 vacation days to make it worthwhile for the family to purchase the insurance. Charging 1 day would not be enough to cover the potential loss, while charging 3 or 4 days would be too expensive and not worth it for the family to purchase.

Continuing with the Same Family from the Preceding Question,suppose a Risk