Suppose you own a beach house on a coast that has a small chance of encountering a hurricane each year. There is a 1% chance that there will be a hurricane this year that would completely destroy your $350,000 home. (Assume that this home is the only store of wealth that you have.) An insurance company has offered you insurance that would reimburse you the entire value of your home in the event of a hurricane. The premium for this insurance is $4,000.

a. What is the expected value of your wealth if you do not purchase insurance?

b. What is the expected value of your wealth if you purchase the insurance at a $4,000 premium?

c. Will a risk-averse person choose to purchase insurance?

d. Will a risk-seeking person choose to purchase insurance?

e. What would the premium have to be to make a risk-neutral person indifferent between buying the insurance and not buying the insurance?

f. If the insurance company offered the premium you found in part (e), would a risk-averse person purchase insurance?