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What is jonathan optimal amount of insurance to purchase

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Question: Jonathan has $1 million in savings and owns a house. With a 0.1% probability, the house burns down and costs $800,000 to rebuild. He can buy insurance at a cost of $1.20 per $1,000 of coverage (for example, if he pays $12 in insurance, he is repaid $10,000 if the house burns down). Jonathan's preferences over realized wealth are given by u(m) = √m.

a. What is Jonathan's optimal amount of insurance to purchase?

b. Suppose Jonathan can "fire-proof" his home, guaranteeing that it will not burn. What is the most that he should be willing to pay to do this?

Reference no: EM132200966

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