Question 3

3. Which lottery payout scheme is better? Suppose you win a raffle held at a county fair and are given the choice between two different ways to be paid. You can either accept the money in a lump sum immediately or in a series of payments over time. If you choose the lump sum payout, you receive $2,850 today. If you choose to collect payments over time, you receive three payments: $1,000 today, $1,000 1 year from today, and $1,000 2 years from today. At an interest rate of 8% per year, the winner would be better off accepting the w , since that choice has the greater present value. At an interest rate of 11% per year, the winner would be better off accepting W, since it has the greater present value. A couple years after you win the raffle, you and your friend are back at the same event. This time, your friend gets lucky and wins the contest, and you both realize the payout schemes are the same as they were back when you won. They now face the decision between collecting their prize as a lump sum or as a series of payments over time. Based on your experience, which piece of advice will be most helpful to your friend? O The lump sum is always better. O The payments over time are always better. ) 1t will depend on the interest rate; advise her to get a calculator. O None of these answers is good advice. Grade It Now Save & Continue 5. Understanding risk aversion Suppose your classmate Janet offers you a wager: She will choose a playing card at random from a deck and pay you $1,000 if it is red, but you have to pay her $1,000 if it is black. Assume your wealth is currently $3,000. The graph shown below plots your utility as a function of wealth. Use the graph to answer the questions that follow. @ 90 + 80 + 70 + c e w0 4+ UTILTY (Units of utility) 2 + 0 + 20 + 0 = 1 t t t 0 1 2 3 4 5 WEALTH (Thousands of dollars) The shape of your utility function implies that you are a W _individual, and, therefore, you W accept the wager because the difference in utility between A and C is w the difference between C and B. Which of the fellowing sentences most appropriately describe why the pain of losing $1,000 is greater than the joy of winning $1,000 for individuals who are risk averse? Check all that apply. [[J Risk-averse people overestimate the probability of losing money. [0 The more wealth that risk-averse people have, the less satisfaction they receive from an additional dollar. [) The more wealth that risk-averse people have, the more satisfaction they receive from an additional dollar. O The utility function of a risk-averse person exhibits the law of diminishing marginal utility. (&1 EN 8 T Save & Continue ATl LML L4