Consider a lottery with three possible outcomes: Payout &nbs...
Consider a lottery with three possible outcomes:
Payout Probability
$2000 .1
$1000 .4
$0 .5
Answer questions 1-2 with reference to the information above
1. What is the expected payout from this lottery?
a. $100
b. $200
c. $350
d. $450
e. $600
2. Which of the following is true with reference to Mike’s willingness to participate in this gamble?
a. If Mike is willing to pay at most $500 to participate in this gamble then he is risk neutral
b. If Mike is willing to pay at most $400 to participate in this gamble then he is risk averse
c. If Mike is willing to pay at most $600 to participate in this gamble then he is risk averse
d. If Mike is willing to pay at most $650 to participate in this gamble then he is risk neutral
e. If Mike is willing to pay at most $450 to participate in this gamble then he is risk seeking
Homework Answers
Answer-1 The correct option is e.) $600
Expected payout from this lottery is
E(X) = 0.1×(2000) +0.4×(1000) + 0
= 200 + 400
= 600
Answer-2 The correct option is b.)If Mike is willing to pay at most $400 to participate in this gamble then he is risk averse
In this situation he is willing to pay less than the expected payout from the lottery. This makes him a risk averse individual.
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