QUESTION 1

Imagine that you have the following pair of concurrent decisions. First examine both decisions, then indicate the options you prefer. Decision 1: Choose between A a sure loss of 1500 B a 75% to lose 2000 and 25% chance to lose nothing Decision 2: Choose between C a sure gain of 480 D a 25% chance to gain 2000 and 75% chance to gain nothing Calculate the expected value of decision 1B and 2D. 1B: 2D: [2 marks] Which options would a risk neutral individual choose? [multiple choice] 1 mark per correct, -1 for incorrect O1B and 2D O1B and 2C O1A and 2D O1A and 2C [3 marks] How do you think respondents in a laboratory experiment would decide in Decision 1 and Decision 2? O most participants will choose 1B and 2C O most participants will choose 1A most participants will choose 1B and 2D Omost participants will choose 1A and 2D [4 marks] What can explain the behavior in the lab for decision 1? [multiple choice] 2 mark per correct, -2 for incorrect O preference for certainty O underestimation of large probabilities individuals are risk loving in the loss domain overweighting of small probabilities concavity of the value function in the gain domain 2. individuals are risk loving in the loss domain [8 marks] Combine options A and D into one lottery and options B and C into another lottery. AD: % chance to win and BC: and % chance to lose % chance to win % chance to lose 27 [2 marks] How would participants choose now? OBC O indifferent between AD and BC O cannot say without more information O AD