Question

Andy and Kim live together. Andy may invest ​$14 comma 000 ​(possibly by taking on an extra job to earn the additional​ money) in​ Kim's education this year. This investment will raise​ Kim's future earnings by ​$20 comma 000 ​(in present valueLOADING... ​terms). If they stay​ together, they will share the benefit from the additional earnings. ​ However, the probability is 20​% that they will split up in the future. If they were married​ (or in a civil​ union) and then​ split, Andy would get half of​ Kim's additional earnings. If they were living together without any legal ties and they​ split, then Andy would get nothing. Suppose that Andy is risk neutral. Will Andy invest in​ Kim's education? Does your answer depend on the​ couple's legal​ status? A. Andy will invest in Kim's education only if they have legal ties. B. Andy will not invest in Kim's education regardless of legal ties. C. Andy will invest in Kim's education regardless of legal ties. D. Andy will invest in​ Kim's education only if they do not have legal ties. E. Andy will be indifferent about investing in​ Kim's education regardless of legal ties.

Answer 1

Answer:

Will Andy invest in​ Kim's education?

• Yes, he should. The expected benefits from investing in Kim's education are higher than the costs regardless of their legal status.

Does your answer depend on the​ couple's legal​ status?

• C. Andy will invest in Kim's education regardless of legal ties.

Explanation:

if Andy and Kim are not married:

initial investment $14,000

expected benefits $20,000 x (1 - 20%) = $16,000

expected gain = $16,000 - $14,000 = $2,000

If Andy and Kim are married:

expected benefits [$20,000 x (1 - 20%)] + ($20,000 x 20% x 1/2) = $16,000 + $2,000 = $18,000

expected gain = $18,000 - $14,000 = $4,000