Question:
Lucy lives in a bad neighborhood, and will be robbed with a 25 percent probability. She cares only about lemonade, but the amount of lemonade she drinks may depend on whether she is robbed. We will use LR to stand for the amount of lemonade she drinks if she is robbed, and LN to stand for the amount of lemonade if she is not robbed. Suppose we can represent Lucy's preferences with an expected utility function, and that her benefit function is W(L) = - 1/L. Plot the indifference curve that runs through the point(LR,LN) = (500,500). Plot the constant expected consumption line that runs through the same point. Is Lucy risk averse, risk loving, or risk neutral? Is Lucy's benefit function concave or convex? Graph it.