I.Suppose that Luu's current wealth is $400 and she faces the following lottery. She can earn $500 with probability _A = ¹/₅, she can earn zero (stay the same) with probability _B = ³/₅ and she can lose $300 with probability _C = ¹/₅. Assume Luu's utility function, defined over her wealth, is U(w) = .

What is the expected value of the lottery? (Do not include the initial wealth endowment, only the value of the lottery.)

EV =

Which utility level would Luu get if she received the expected value of the lottery for sure? (Include Luu's initial wealth endowment.)

U (EV) =

II.What is Luu's expected utility (EU)?

EU =

Why is the utility of the expected value of the lottery different from the expected utility

oBecause Luu is risk-loving

oBecause Luu is risk-neutral

oBecause Luu is risk-averse

III.What is the guaranteed payoff w*, over and above the initial wealth endowment, at between accepting the guaranteed payoff and playing the lottery?

w* =

IV.Assume that Sara's utility function is U(w) = w^1/4 and that Sara's current wealth w is $400. that Angela's utility function is U(w) = w^1/4 and that her initial wealth is $1000.

Would Sara derive more or less surplus (utility) from this lottery than Luu?

oSara derives more surplus than Luu and will enter the lottery.

oSara derives the same surplus as Luu and will enter the lotter.

oSara derives the same surplus as Luu and will not enter.

oSara derives less surplus than Luu and will not enter.

oSara derives more surplus than Luu and will not enter.

oSara derives less surplus than Luu and will enter the lottery.

Would Angela derive more or less surplus from this lottery than Luu?

oAngela derives more surplus than Luu and will enter the lottery.

oAngela derives the same surplus as Luu and will not enter.

oAngela derives less surplus than Luu and will enter the lottery.

oAngela derives more surplus than Luu and will not enter.

oAngela derives less surplus than Luu and will not enter.

oAngela derives the same surplus as Luu and will enter the lottery.

Which kind of people do we expect to have a higher propensity to enter this kind of lottery?

oPeople who are risk-averse

oPeople who are risk-loving

oPeople who have high initial wealth

oPeople who have low initial wealth

oNone of the above