The Conduire family owns three cars and is considering buying insurance to cover the cost of repairs.They face two possible states: state 1,in which their cars need no repairs and their income available for purchasing other goods and services is equal to $50,000;and state 2,in which their cars need $10,000 worth of repairs and their income available for purchasing other goods and services is reduced to $40,000.The probability of occurrence is 0.5 for each state.They can buy insurance that will cover the full cost of repairs for $5,000.If the Conduires are risk-averse and maximize their expected utility,they will:
A)buy the insurance.
B)be indifferent between buying and not buying the insurance since their expected income for purchasing other goods and services is $45,000 regardless of what they do.
C)not buy the insurance since buying it does not increase their expected income for purchasing other goods and services.
D)put $10,000 in savings to pay for any required repairs and not buy insurance.

Question

Quizplus · Accepted Answer

The Conduires are risk-averse, which means they prefer to avoid risk even if it means sacrificing potential gains. Given that there is a 50% chance their cars will need repairs costing $10,000, it is likely that they will opt for insurance, which will cover the full cost of repairs for $5,000. This way, they can avoid the risk of having to pay the full cost of repairs in state 2 and have peace of mind. Buying insurance will increase their expected income for purchasing other goods and services as they will not have to spend $10,000 on car repairs. Therefore, the best choice for the Conduires is to buy the insurance.

The Conduire Family Owns Three Cars and Is Considering Buying