Bob’s utility function is shown in the above figure. He currently has

Bob’s utility function is shown in the above figure. He currently has $100 worth of property, but there is a 50% chance that all of it will be stolen. An insurance company offers to reimburse Bob for his loss if the money is stolen.

What is the most that Bob would pay for such a policy? Explain.

ANSWER

A risky life leaves Bob with expected utility that could be had from a certain $30. Thus, he is willing to part with up to $70 to insure himself against such a loss.