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Question: you would like to buy home insurance for a year...

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You would like to buy home insurance for a year. The value of your home at the end of the year will be $100; after a fire the value of the remaining lot will be $20. The probability of fire is Pf= 0.25. You are risk-averse and would like to maximize Expected Utility or E(U). Your Utility function is U = M0.5where M = money. Graph your U function and map the prospects and their corresponding utility levels; additionally, compute and map your E(U) as well as the E(M). What is the maximum premium (MP) you would be willing to pay to insure your home for a year? Show that no matter what happens (fire or no fire) you end up with your E(U). Show that your U[E(M)] is greater than your E(U); what does U[E(M)] > E(U) prove?

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