12. Complete the following examples o The Hotel California faces a risk that an earthquake will cause a $200 million loss; probability is 0.02. The owner of the hotel, Eddie Eagle, has a utility function of U=W05, where Wis the owner's wealth (as measured by the value of the hotel in millions of dollars). Suppose the initial value of the hotel is $225 million (W=225). What is the expected loss for Eddie Eagle? What is Eddie Eagle's expected utility? Risk premium?

ENGR.ECONOMIC ANALYSIS
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Chapter1: Making Economics Decisions
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12. Complete the following examples
The Hotel California faces a risk that an earthquake will cause a $200 million loss; probability is
0.02. The owner of the hotel, Eddie Eagle, has a utility function of U= W05, where Wis the owner's
wealth (as measured by the value of the hotel in millions of dollars). Suppose the initial value of
the hotel is $225 million (W = 225). What is the expected loss for Eddie Eagle? What is Eddie
Eagle's expected utility? Risk premium?
o The Anderson family lives in the Arizona wilderness. Their property is at risk for being destroyed
by a forest fire. It is estimated that each year the Anderson face a 5 percent probability of a $500,000
loss. The Anderson family has a utility function of U = W 0.7, where W is wealth and measured in
dollars. Suppose their current wealth is $1 million. What is the family's expected loss from fire?
What is the Anderson family's expected utility? What is the maximum value the Andersons will
pay for insurance to completely protect their home? What is the risk premium?
Transcribed Image Text:12. Complete the following examples The Hotel California faces a risk that an earthquake will cause a $200 million loss; probability is 0.02. The owner of the hotel, Eddie Eagle, has a utility function of U= W05, where Wis the owner's wealth (as measured by the value of the hotel in millions of dollars). Suppose the initial value of the hotel is $225 million (W = 225). What is the expected loss for Eddie Eagle? What is Eddie Eagle's expected utility? Risk premium? o The Anderson family lives in the Arizona wilderness. Their property is at risk for being destroyed by a forest fire. It is estimated that each year the Anderson face a 5 percent probability of a $500,000 loss. The Anderson family has a utility function of U = W 0.7, where W is wealth and measured in dollars. Suppose their current wealth is $1 million. What is the family's expected loss from fire? What is the Anderson family's expected utility? What is the maximum value the Andersons will pay for insurance to completely protect their home? What is the risk premium?
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