Question

B) Harley's current wealth is $600, but there is a .25 probability that he will lose $100. Harley is risk averse. He has an opportunity to buy insurance that would restore his $100 if he loses it. a)Harley would be willing to pay a bit more than $25 for this insurance b)Harley would be willing to pay up to $25 for this insurance c)Since Harley is risk averse, he would not be willing to pay anything for this insurance, it is too risky. d)Since Harley's utility function is not specified, we cannot tell how much he would be willing to pay for this insurance. e)Harley would not be willing to pay more than $16.66 for this insurance.

Answer 1

b) Harley would be willing to pay up to $25 for this insurance

Step-by-step explanation:

A risk averse person is a person that tries to reduce uncertainty whenever he is exposed to it.

Since Harley is risks averse, the value of the amount he would be willing to pay can be calculated as follows:

Amount willing to pay = Probability of loss * possible amount to lose = 2% * $100 = $25.

Therefore, Harley would be willing to pay up to $25 for this insurance.