Consider a household that possesses $100,000 worth of valuables (computers, stereo equipment, jewelry, and so forth). This household faces a 0.10 probability of a burglary. If a burglary were to occur, the household would have to spend $20,000 to replace the stolen items. Suppose it can buy an insurance policy for $500 that would fully reimburse it for the amount of the loss.
a) Should the household buy this insurance policy?
b) Should it buy the insurance policy if it cost $1,500? $3,000?
c) What is the most the household would be willing to pay for this insurance policy? How does your answer relate to the concept of risk premium discussed in the text?