![Question 2 [25 marks] Consider Edgar who has preferences over money represented by utility function (y) = (y2/3. He has an in](http://img.homeworklib.com/questions/48fe9450-78e5-11ea-ad7c-fb3f02f3f3ed.png?x-oss-process=image/resize,w_560)
![c) (5 marks] Calculate Edgars certainty equivalent (CE), and provide an interpretation for it, in the context of this lotter](http://img.homeworklib.com/questions/49715310-78e5-11ea-89a2-5577c19afd18.png?x-oss-process=image/resize,w_560)
Homework Answers
c)
Probability of loss=p=(2/3)
Income in case of loss=150-25=$125
Utility in case of loss=U(125)=125^(2/3)=25 utils
Probability of win=1-p=1/3
Income in case of win=150+66=$216
Utility in case of win=U(216)=216^(2/3)=36 utils
Expected utility in case of game=(2/3)*25+(1/3)*36=28.666667 utils
Let the certainty equivalent be X, then
U(X)=expected utility in case of game=28.666667
X2/3=28.666667
X=28.6666673/2=$153.48
It means that a certain income of $153.48 will leave the person indifferent between playing lottery and not playing. It also indicates that certain addition of $3.58 in his income will be equivalent of playing the given lottery in the given case.
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