Bob is considering whether to purchase a warranty to provide insurance on his new computer. There is an 80% chance that his computer works well for the next year and a 20% chance that it will crash and need to be replaced. Bob's value for his computer is $625 if it does not break down and $0 if it crashes. Bob has expected utility preferences with utility function given by u(c) = √c. a) What is Bob's expected utility from buying the computer without the warranty? (Write down both the formula for his expected utility and the number his expected utility is equal to). b) If Bob pays $x for the warranty that would replace his computer with a new one if it crashes, then he would be sure to have a payoff of ($625 $x) no matter what happened to his computer. Write an equation that can be solved to find the largest price (the largest value of $x) that Bob would be willing to pay for such an insurance policy. Solve for that price. -

Bob is considering whether to purchase a warranty to provide insurance on his new computer. There is an 80% chance that his computer works well for the next year and a 20% chance that it will crash and need to be replaced. Bob's value for his computer is $625 if it does not break down and $0 if it crashes. Bob has expected utility preferences with utility function given by u(c) = √c. a) What is Bob's expected utility from buying the computer without the warranty? (Write down both the formula for his expected utility and the number his expected utility is equal to). b) If Bob pays $x for the warranty that would replace his computer with a new one if it crashes, then he would be sure to have a payoff of ($625 $x) no matter what happened to his computer. Write an equation that can be solved to find the largest price (the largest value of $x) that Bob would be willing to pay for such an insurance policy. Solve for that price. -

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.1P

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