interactions and eost benefit {raming Retum to part [b] of the above problem. Frame the question of
Question:
interactions and eost benefit {raming Retum to part [b] of the above problem. Frame the question of whether to purchase lottery L in incremental terms, by focusing on Ralph's eertain equivalent.
Consider the case where the existing and new lottery outeomes are independent. If the additional lottery is not acquired, Ralph's eertain equivalent is 2,250; if it is acquired, the eertain equivalent drops to 2,185.66. The incremental certain equivalent is -64.34.
In tum, this can be thought of as an expected benefit of .5(3,000) + .5(0) =
1,500, an acquisition eost of 1,000 and a "risk eost" of 564.34. So the net gain is 1,500 - 1,000 - 564.34.
a] Repeat the above calculation for the case of perfect negative eorrelation between the lottery outeomes.
b] Why does the "risk eost" component of the ca1culation depend on the correlation between the existing and proposed lottery outeomes?
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