-Larry Owns a Car Worth $20,000, and That Is His

question 213

Essay

-Larry owns a car worth $20,000, and that is his only wealth. There is a 10 percent chance that Larry will have an accident within a year. If he does have an accident, his car is worthless. Larry's utility of wealth curve is shown in the figure above. An insurance company agrees to pay a car owner like Larry the full value of his car in case of an accident if the car owner buys the company's insurance policy. The company's operating expenses are $2,500 per policy.
a) What is Larry's expected wealth?
b) What is Larry's expected utility?
c) What is the maximum amount that Larry is willing to pay for car insurance?
d) What is the minimum premium that the insurance company is willing to accept?
e) Will Larry buy the insurance policy? Why or why not?

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Definitions:

Work

A range of activities involving mental or physical effort done in order to achieve a purpose or result.

Harold Geneen

A prominent business executive known for his role in transforming ITT Corporation into a major conglomerate during the mid-20th century.

Job Enrichment

Designing or redesigning a job by incorporating motivational factors into it.

Differentiation

A strategy or process that involves making a product or service distinct from those of competitors, often through innovation or quality improvement.