Question
Suppose an individual has $64 but has a 25% chance of losing $39 (75% of the time she still has $64). This person's utility of
Suppose an individual has $64 but has a 25% chance of losing $39 (75% of the time she
still has $64). This person's utility of money is U(M) = SQRT(M).
(a) Is this person risk averse, risk loving, or risk neutral? Explain mathematically.
(b) Calculate the expected value of the gamble and the expected utility this person faces with this gamble.
(c) Calculate the certainty equivalent, or the certain amount of money she would be willing to have rather that have to take this gamble. Is this greater than, less than, or equal to the expected value of the gamble? How much is this person willing to pay for insurance against the loss?
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