Answer:
Expected profit policy 1 = $40
Expected profit policy 2 = $20
Expected profit policy 3 = $10
Step-by-step explanation:
X values | Probability P(x)
0 | 0.80
1,000 | 0.08
5,000 | 0.10
10,000 | 0.02
A particular company offers three different policies:
Policy 1: $200 deductible with a $780 premium
Policy 2: $500 deductible with a $700 premium
Policy 3: $1000 deductible with a $590 premium
The company pays X - Y in damages if X > Y and 0 otherwise.
So the expected profit is given by
Expected profit = Premium amount - Expected payout
Expected profit = Premium amount - [ (X - deductible) × P(x) ]
Expected profit Policy 1:
E(x) = $780 - [ 0×0.80 + (1,000 - 200)×0.08 + (5,000 - 200)×0.10 + (10,000 - 200)×0.02 ]
E(x) = $780 - [ 0 + 64 + 480 + 196 ]
E(x) = $780 - $740
E(x) = $40
Expected profit Policy 2:
E(x) = $700 - [ 0×0.80 + (1,000 - 500)×0.08 + (5,000 - 500)×0.10 + (10,000 - 500)×0.02 ]
E(x) = $700 - [ 0 + 40 + 450 + 190 ]
E(x) = $700 - $680
E(x) = $20
Expected profit Policy 3:
E(x) = $590 - [ 0×0.80 + (1,000 - 1,000)×0.08 + (5,000 - 1,000)×0.10 + (10,000 - 1,000)×0.02 ]
E(x) = $590 - [ 0 + 0 + 400 + 180 ]
E(x) = $590 - $580
E(x) = $10
Therefore, the expected profits for the three policies are:
Expected profit policy 1 = $40
Expected profit policy 2 = $20
Expected profit policy 3 = $10
= 0.55)