The decisions made by residential customers in the Mountain Bell Colorado teleph

Question

The decisions made by residential customers in the Mountain Bell Colorado telephone service area concerning the purchase of inside-wire maintenance service contracts have been examined. An IWM contract allows a consumer to insure against potential telephone line trouble within his home; for a monthly fee, the telephone company agrees to repair any telephone line problems at no charge when the repair occurs. The alternative is not to purchase this contract and to bear the cost of any repair as needed. The estimated von Neumann-Morgenstern utility index for the representative consumer in this area to be

U = 1935.1(W + .6849)0.37.

At the time the research was done, the average consumer had monthly income of $1,699.40. The monthly probability of telephone line trouble was 0.5%, and the typical repair charge was $55. What was the maximum amount this consumer would pay per month for an IWM contract?

Explanation / Answer

W= 1699.40

Utility index U = 1935.10 x( 1699.40+0.6849)^0.37

                                = 1935.10 x 15.6774

                                = 30,337.34

Annual cost of IMV contract = 30,337.34 x0.5%

                                                                =151.69

Maximum monthly payment = annual cost/ 12

                                                                = 151.69/12

                                                                =12.64

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