-Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. With no insurance, Steve's expected utility is
A) 97.
B) 84.
C) 90.
D) 100.

Question

-Steve owns a motorcycle valued at $5,000, and that is his only asset. There is a 5 percent chance that Steve will have an accident within a year. If he does have an accident, his motorcycle is worthless. Steve's utility of wealth curve is shown in the figure above. An insurance company agrees to pay Steve the full value of his motorcycle in case of an accident if he buys the company's insurance policy. The company's operating expenses are $500 per policy. With no insurance, Steve's expected utility is
A) 97. 
B) 84. 
C) 90. 
D) 100.

Quizplus · Accepted Answer

Steve's expected utility without insurance is calculated by considering the probability of having an accident and the utility of his wealth in both scenarios (with and without an accident). The expected utility is a weighted average of the utility in both cases.

-Steve Owns a Motorcycle Valued at $5,000, and That Is