Question

3) Burkhard and Anuiit are neighbors in Davis. Burkhard is a full professor, whereas Anuiit is a lowly Assistant Professor who has recently joined the same University. Each owns a car valued at $12000. Neither has comprehensive insurance (which covers losses due to theft). Burkhard's wealth, including the value of his car, is $100,000. Anuiit's wealth, including the value of his car, is $60,000. Burkhard and Anujit have identical utility of wealth functions, U(W) = 10.5. Burkhard and Anuiit can park their cars on the street or in a rented garage. In Davis, the probability that a street-parked car is stolen is 20% over a one-year period. A garage-parked car will not be stolen. What is the largest amount that Burkhard and Anuiit are willing to pay for a garage? Compare their willingness-to-pay and include a comparison of their Arrow-Pratt measures of risk aversion given their wealth levels.

Answer 1

Answer:

Given that:

Burkhard and Anuiit are neighbors in Davis. Burkhard is a full professor, whereas Anuiit is a lowly Assistant professor who has recently joined the same University. Each owns a car valued at$12000.

Burkhard

Expected utility

$=0.2\times \sqrt{100000-12000}+\sqrt{100,000}$

$=312.31$

$=312.31=\sqrt{100000-RP}$

(312.31)2 = 100000 - RP

$RP=2462$ the maximum willingness to pay.

Anuiit

expected utility

$0.2\sqrt{60,000-12000}+0.8\times \sqrt{60,000}$

$=239.77$

$239.77=\sqrt{60,000-RP}$

$RP=(239.77)^{2}=60,000$

$RP=2510$

the maximum willingness to pay.