You value your time at $50 an hour. If you choose to drive to your destination it will cost you $150 and the

drive will take you 6 hours with probability 0.9 and 7 hour

s with probability 0.1

. In short,

you face a lottery

in which you will

spend $450 ($150 + cost of 6 hours) with probability 0.9 or

$500 ($150 + cost of 7 hours)

with probability 0.1

. If you fly, it will cost you $300 and your trip will last 2 hours with probability 0.7 and 4

hours with probability 0.3.

Here you face a lottery in which you will spend

$400 with probability 0.7 and

$500 with probability 0.3.

Assume that your total as

sets are

$50

0 and that

y

ou have

the following utility

for

the assets that remain after your spending

:

u($x) =

x

(the so called Bernoulli utility.)

Please note that the

utility function is defined on assets and not expenditures:

x

only makes sense when

0

x

while an

expenditure of, say, $100, formally is

-

100.

What should you do? Drive or fly?

Problem 5

(3p)

Tom