Ms. Chaltu is planning an around-the-world trip on which she plans to spend $10,000. The utility from the trip is a function of how much she actually spends on it (α), given by U (α) = ln α a. If there is a 25 percent probability that Ms. Chaltu will lose $1,000 of her cash on the trip, what is the trip’s expected utility? b. Suppose that Ms. Chaltu can buy insurance against losing the $1,000 (say, by purchasing traveler’s checks) at an “actuarially fair” premium of $250. Show that her expected utility is higher if she purchases this insurance than if she faces the chance of losing the $1,000 without insurance. c. What is the maximum amount that Ms. Chaltu would be willing to pay to insure her $1,000?

/in /by

Ms. Chaltu is planning an around-the-world trip on which she plans to spend $10,000.
The utility from the trip is a function of how much she actually spends on it (α), given by
U (α) = ln α
a. If there is a 25 percent probability that Ms. Chaltu will lose $1,000 of her cash on the
trip, what is the trip’s expected utility?
b. Suppose that Ms. Chaltu can buy insurance against losing the $1,000 (say, by
purchasing traveler’s checks) at an “actuarially fair” premium of $250. Show that

her expected utility is higher if she purchases this insurance than if she faces the
chance of losing the $1,000 without insurance.
c. What is the maximum amount that Ms. Chaltu would be willing to pay to insure her
$1,000?

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