Question

3) Burkhard and Anujit are neighbors in Davis. Burkhard is a full professor, whereas Anujit is a lowly Assistant Professor who has recently joined the same University. Each owns a car valued at $12000. Neither has comprehensive insur- ance (which covers losses due to theft). Burkhard's wealth, including the value of his car, is $100,000. Anujit's wealth, including the value of his car, is $60,000. Burkhard and Anujit have identical utility of wealth functions, U(W) = W0.5. Burkhard and Anujit 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 Anujit 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

Burkhard Expected utility -0.2 XV OD DDO - 12000+ 0.8 IOD, 000 = 312.31 312.31 - v100000 - RP (312.31 - 100000 - RP RP=12462 ] the maximum willingness to pay. Anugil Expected utility 0.25 60,000-12000+ 0.8XJ 60,000 = 239.77 239.77 = v 60,000 - RP RP = (239.77) - 60,000 RP = 12510 the maximum willing 2 to pay .