(See Problem 2

question 3

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 $400,000 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) 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.
• 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) no insurance since the cost per dollar of insurance exceeds the probability of a flood.
• 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

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