Now suppose you wish to estimate the utility of $5,000. You are indifferent between

(a) receiving

$10,000 for sure and

(b) receiving $40,000 with probability p and $5,000 with probability 1 - p, where p = 1/3. Use this to calculate the utility of $5,000.

Hint. Suppose, in general, that you fix utilities for salaries Q1 and Q2 (here, $10,000 and $40,000, respectively) and wish to calculate the utility of some salary Q that is less than $10,000. If you are indifferent between

(a) receiving Q1 and

(b) a lottery in which you receive Q2 with probability p and Q with probability 1 - p, then

This allows you to solve for u(Q) in terms of u(Q1) and u(Q2).

Transcribed Image Text:

= u(Qi) (1p)u(Q) + pu(Q2)