Question 1007234: Teddy is considering buying flood insurance. The cost of flood insurance is 400$ per year. Teddy predicts that there is a 20% chance that his house will flood and estimates that a flood will cost $1,000 in damages. If he gets insurance and there is flood damage, the insurance company will pay $1,000 for the damages. Since Teddy only paid 400$ for the insurance , he will essentially save himself 600$. What is the expected value of the savings/losses for Teddy buying insurance?
a) -200$
b) 600$
c) -400$
or
d) 120$
?
Thank you. I'm pretty stuck.
Answer by Boreal(15235)   (Show Source):
You can put this solution on YOUR website! Expected payoff from insurance:
$1000*0.20=$200
0*0.80=0
Expected payoff is $200.
He pays $400 for insurance.
He gains only if there is a flood, but he has an expected LOSS of $200.
A
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