(See Problem 2

question 16

Multiple Choice

(See Problem 2.) Willy's only source of wealth is his chocolate factory. He has the utility function , where p is the probability of a flood, 1 - p is the probability of no flood, and c_f and c_nf are his wealth contingent on a flood and on no flood, respectively. The probability of a flood is p = . The value of Willy's factory is $500,000 if there is no flood and 0 if there is a flood. Willy can buy insurance where if he buys $x worth of insurance, he must pay the insurance company $ whether there is a flood or not, but he gets back $x from the company if there is a flood. Willy should buy

• A) no insurance since the cost per dollar of insurance exceeds the probability of a flood.
• B) enough insurance so that if there is a flood, after he collects his insurance, his wealth will beof what it would be if there is no flood.
• C) enough insurance so that if there is a flood, after he collects his insurance, his wealth will be the same whether there is a flood or not.
• D) .enough insurance so that if there is a flood, after he collects his insurance, his wealth will beof what it would be if there is no flood.
• E) enough insurance so that if there is a flood, after he collects his insurance, his wealth will beof what it would be if there is no flood

---

Definitions:

Laffer Curve

An illustration of the relationship between tax rates and tax revenue, suggesting that there is an optimal tax rate that maximizes revenue.

Tax Rate Reductions

A decrease in the percentage at which income or transactions are taxed by governmental authorities.

Price Inelastic

A situation where the demand for a good or service remains relatively unchanged despite changes in its price.

Consumption

The use of goods and services by households or individuals, often considered in terms of the total amount consumed in an economy.