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Finance Questions 1. Why might some prefer a prix fixe (fixed price) dinner costing about the same as an la carte one (where you pay individually for each item)? (Assume the food is identical.) 2. Consider a person with the following utility function over wealth: u(w) = e w, where e is the exponential function (approximately equal to 2.7183) and w = wealth in hundreds of thousands of dollars. Suppose that this person has a 40% chance of wealth of $100,000 and a 60% chance of wealth of $2,000,000 as summarized by P(0.40, $100,000, $2,000,000). a. What is the expected value of wealth? b. Construct a graph of this utility function (recall your excel?). c. Is this person risk averse, risk neutral, or a risk seeker? d. What is this person's certainty equivalent for the prospect? 3. Consider two prospects. Problem 1: Choose between Prospect A: $2,500 with probability 0.33 $2,400 with probability 0.66 Zero with probability 0.01 $2,400 with probability 1.00 Prospect B: Problem 2: Choose between Prospect C: $2,500 with probability 0.33 Zero with probability 0.67 Prospect D: $2,400 with probability 0.34 Zero with probability 0.66 It has been shown by Daniel Kahneman and Amos Tversky (1979, \"Prospect theory: An analysis of decision under risk,\" Econometrica 47(2), 263-291) that more people choose B when presented with problem 1 and when presented with problem 2, most people choose C. These choices violate expected utility theory. Why? Actions for Choice Between Prospects Consider two prospects. Problem 1: Choose between Prospect A: $2,500 with probability $2,400 with probability Zero with probability Prospect B: $2,400 with probability Pi Xi Ei = Pi*Xi 0.33 0.66 0.01 1 2500 2400 0 2400 825 1584 0 2400 Problem 2: Choose between Prospect C: $2,500 with probability Zero with probability Prospect D: $2,400 with probability Zero with probability 0.33 0.67 0.34 0.66 2500 0 2400 0 825 0 816 0 Sum 2409 2400 825 816 It has been shown by Daniel Kahneman and Amos Tversky (1979, \"Prospect theory: An analysis of decision under risk,\" Eco choose B when presented with problem 1 and when presented with problem 2, most people choose C. These choices viola when presented with problem 1, Prospect A is prefered as is sum of expecation is 2409. which is greater than that of B whose sum is 2400. when presented with problem 2, Prospect c is prefered as is sum of expecation is 825. which is greater than that of D whose sum is 816. ysis of decision under risk,\" Econometrica 47(2), 263-291) that more people e choose C. These choices violate expected utility theory. Why? Actions for Choice Between Prospects Consider two prospects. Problem 1: Choose between Prospect A: $2,500 with probability $2,400 with probability Zero with probability Prospect B: $2,400 with probability Pi Xi Ei = Pi*Xi 0.33 0.66 0.01 1 2500 2400 0 2400 825 1584 0 2400 Problem 2: Choose between Prospect C: $2,500 with probability Zero with probability Prospect D: $2,400 with probability Zero with probability 0.33 0.67 0.34 0.66 2500 0 2400 0 825 0 816 0 Sum 2409 2400 825 816 It has been shown by Daniel Kahneman and Amos Tversky (1979, \"Prospect theory: An analysis of decision under risk,\" Eco choose B when presented with problem 1 and when presented with problem 2, most people choose C. These choices viola when presented with problem 1, Prospect A is prefered as is sum of expecation is 2409. which is greater than that of B whose sum is 2400. when presented with problem 2, Prospect c is prefered as is sum of expecation is 825. which is greater than that of D whose sum is 816. ysis of decision under risk,\" Econometrica 47(2), 263-291) that more people e choose C. These choices violate expected utility theory. Why