Question

A farmer lives on a flat plain next to a river. In addition to the farm, which is worth $F, the farmer owns financial assets worth $A. The river bursts its banks and floods the plain with probability P, destroying the farmIf the farmer is risk averse, then the willingness to pay for flood insurance unambiguously falls when:________. A) F is higher, and A is lower.B) P is lower, and F is higher.C) F & A are higher.D) P is lower, and A is lower.E) A is higher, and F is lower.

Answer 1

Answer:

E) A is higher, and F is lower.

Explanation:

If the farmer is risk averse, he tends to always take the decision which will minimize risk.

His financial assets (A) are not affected by floods, so the higher they are, less likely he will be to pay for flood insurance.

If P is the likelihood of a flood happening, the lower the risk P, then the lower the willingness to pay for flood insurance will be.

If F is lower, then the farmer is unlikely to spend money insuring the farm.

Therefore, analyzing the answer choices, the only that fits the above description is E) A is higher, and F is lower.