You are the owner of a widget factory that is expected to generate $100 in profits over the next 12 months. Unfortunately, your factory is in a flood plain. There is a small chance that a flood will cause damage that will entirely wipe out your profit. To be more specific, you estimate that there is a 99% probability that you will earn $100, and a 1% probability that there will be a flood and you will earn $0. Assume that your utility is based solely on your earnings according to

where C is the earnings from the factory over the next 12 months. How much would you be willing to pay for flood insurance that would pay you $100 in the event of a flood if θ = 0.50? What if θ = 2.0?

Transcribed Image Text:

U = (C+1)-0-1 1-0