York University Final Examination Course Director: Chiang Course Number: ECON 2300.03A I. Consider a two-person economy (persons A and B). Both A and...

You have

$2500

,

which can buy you a projection TV

($1600)

and a VCR

($900)

.

You plan to take them home with your own car. Due to the snowy weather

and your driving skill, the probability of having an accident is 0.5. When the

accident occurs, both TV and VCR will be totally damaged (i.e., their residual

values = zero). The transportation costs (money as well as time) are assumed

to be relatively minor and can therefore be ignored. For simplicity, assume that

your preference function is

U

=

√

w,

where w is the total value of these two

products.

(a) You can bring them home in one trip or in two separate trips. Which one

do you prefer?

(b) There is an insurance that you can purchase. The full coverage insurance

may cost you as much as

$1250

.

Are you better o

ff

in buying this insurance?

Draw a diagram to prove your assertion.

(c) The other option is to buy a partial coverage insurance. It pays 50 percent

of your losses at a cost of

$625

(half of what you pay under the full coverage

insurance). Compare this with the full coverage insurance and with no

insurance.

(d) The insurance company from which you purchase the insurance can go

bankrupt with a probability of 25%. Bankruptcy would make it impossible

for you to claim the loss, if incurred. What happens to your results above?