Uncertainty and Taste for Lotteries

Problem Set due Jul 28, 2020 06:30 WIB

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Problem PS8.4.1

2 points possible (graded)

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

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

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unanswered

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

()=

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Problem PS8.4.2

2 points possible (graded)

What is Luu's expected utility (EU)?

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

Because Luu is risk-loving

Because Luu is risk-neutral

Because Luu is risk-averse

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Problem PS8.4.3

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What is the guaranteed payoff, over and above the initial wealth endowment, at which Luu is indifferent between accepting the guaranteed payoff and playing the lottery?

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Problem PS8.4.4

3 points possible (graded)

Assume that Sara's utility function is()=^1/4 and that Sara's current wealth

is $400. Finally, assume that Angela's utility function is()=^1/4and that her initial wealth is $1000.

Would Sara derive more or less surplus [utility] from this lottery than Luu?

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

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

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

Sara derives less surplus than Luu and will not enter.

Sara derives more surplus than Luu and will not enter.

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

unanswered

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

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

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

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

Angela derives more surplus than Luu and will not enter.

Angela derives less surplus than Luu and will not enter.

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

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

(Select each correct answer.)

People who are risk-averse

People who are risk-loving

People who have high initial wealth

People who have low initial wealth

None of the above

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