Question

a,b and c. Please show work, thank you!

3. The table below contains a person's total utility from different levels of income. His current income is 25K. The person has the choice of playing a game where he has 80% chance of losing 1k (ending up with income=24k) and 20% chance of winning 4k (ending up with income=29k) Income Utility ($1000) 2050 21 69 86 101 114 125 134 27 141 28 146 149 30 150 a. What is his expected income if he plays this game? How does that compare to his current income when not playing? b. Will he choose to play? To find out, calculate his expected utility when playing, and compare it to the utility when he is not playing. c. Is this person risk-averse, risk-neutral, or risk-seeking?

Answer 1

A) EC = .8*24 + .2*29

= 19.2 + 5.8

= 25

its equal to the current income, if he doesn't play gamble

B) EU = .8*U(24) + .2*U(29)

= .8*114 + .2*149

= 121

U(25) = 125

As EU < U(25), so he will not choose to play

c) finding Certainty equivalent CE

U(CE) = EU = 121

So CE is less 25, hence EC-CE >0, thus individual is risk averse