What is the expected value decision?

Consider the car-rental insurance scenario in Problems 3 and 10. Use the approach described in this chapter to develop your personal utility function for the payoffs associated with this decision. Determine the decision that would result using the utilities instead of the payoffs. Is the decision consistent with your choice?

Problem 3

Suppose that a car-rental agency offers insurance for a week that costs $75. A minor fender bender will cost $2,000, whereas a major accident might cost $16,000 in repairs. Without the insurance, you would be personally liable for any damages. What should you do? Clearly, there are two decision alternatives: take the insurance, or do not take the insurance. The uncertain consequences, or events that might occur, are that you would not be involved in an accident, that you would be involved in a fender bender, or that you would be involved in a major accident. Develop a payoff table for this situation. What decision should you make using each strategy?

a. aggressive strategy

b. conservative strategy

c. opportunity-loss strategy

Problem 10

For the car-rental situation described in Problem 3, assume that you researched insurance industry statistics and found out that the probability of a major accident is 0.05% and that the probability of a fender bender is 0.16%. What is the expected value decision? Would you choose this? Why or why not?