Willy's Only Source of Wealth Is His Chocolate Factory

question 4

Multiple Choice

Willy's only source of wealth is his chocolate factory.He has the utility function pc^1/2_f +(1 - p) c^1/2_nf, 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 = 1/6.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 $2x/17 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 be 1/4 of what it would be if there were 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 was a flood or not.
• D)enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/3 of what it would be if there were no flood.
• E)enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/5 of what it would be if there were no flood.

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Definitions:

Incentive

A motivation or reason for doing something, often a reward or benefit that encourages specific behavior.

Delay Of Gratification

The ability to resist the temptation for an immediate reward and wait for a later reward, often associated with better psychological outcomes.

Maslow's Hierarchy

A theory in psychology proposed by Abraham Maslow, depicting a five-tier model of human needs, arranged in a hierarchy, stating that as basic needs are fulfilled people become motivated to achieve higher level needs.

Culture-Specific

Refers to behaviors, norms, or phenomena that are unique or particular to a specific culture.