Willyâs only source of wealth is his chocolate factory. He has the utility function p(cf)^1/2 + (1- p) (cnf) 1/2, where p is the probability of a flood, 1- p is the probability of no flood, and cf and cnf are his wealth contingent on a flood and on no flood, respectively. The probability of a flood is p = 1/13. The value of Willyâs 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 $3x/15 whether there is a flood or not, but he gets back $x from the company if there is a flood.
1. 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 the same whether there is a flood or not.
C. enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/9 of what it would be if there is no flood.
D. 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 is no flood.
E. enough insurance so that if there is a flood, after he collects his insurance, his wealth will be 1/7 of what it would be if there is no flood.