Lucy has current wealth of $100, 000. She has just been sent a notice to pay...

Lucy has current wealth of $100, 000. She has just been sent a notice to pay $500 for speeding. Lucy decides not to pay and to go to court. There she will either get off (because of insufficient evidence)and pay nothing or will have to pay the fine plus the court cost which together amount to $1,000. Lucy sees her chances of getting off at 50%. (a) Suppose Lucy is an expected utility maximizer. Draw a graph with a utility function that can explain Lucy’s choice. Clearly label the wealth axis. Mark the expected utility of going to court and the utility of paying the fine. (b) Can Lucy be an expected utility maximizer if she tells you that she would not only go to court but also reject gambles of winning or loosing $50 with equal probability for all wealth levels. (c) Now suppose Lucy is behaving according to prospect theory and sees her current wealth level as her reference point to which she evaluates changes. Draw a graph with a value function that can explain Lucy’s choice to go to court. Clearly label the wealth axis. Mark the expected valuation of going to court and the value of paying the fine (assume that Lucy puts a probability weight of .5 on both winning and losing in court). (d) In the same diagram show the expected valuation of the gamble of winning or losing $50 with equal probability. Which feature of Prospect Theory is responsible for Lucy rejecting the gamble? (e) Assume a functional form for the value function and show that it can explain Lucy’s choices. (Hint: all typically used functional forms will do.

Solutions

Expert Solution

Rahul Sunny answered 1 year ago

Next > < Previous

Related Solutions

1. Lucy has current wealth of $100, 000. She has just been sent a notice to...

1. Lucy has current wealth of $100, 000. She has just been sent a notice to pay $500 for speeding. Lucy decides not to pay and to go to court. There she will either get off (because of insufficient evidence)and pay nothing or will have to pay the fine plus the court cost which together amount to $1,000. Lucy sees her chances of getting off at 50%. (a) Suppose Lucy is an expected utility maximizer. Draw a graph with a...

Peter and Mark are considering buying a Treasury Bill that promises to pay $100 000 in...

Peter and Mark are considering buying a Treasury Bill that promises to pay $100 000 in 91 days. Peter has a time value of money of 8% per annum and Mark has a time value of money of 6% per annum.  a) Identify, with reason(s) which one of the two will be willing to pay more for the Treasury Bill. b) Suppose the Treasury Bill was for 182 days, what would this change in maturity do to the price...

Harley’s current wealth is $600, but there is a 0.25 probabilitythat he will lose $100....

Harley’s current wealth is $600, but there is a 0.25 probability that he will lose $100. Harley is risk neutral. He has an opportunity to buy insurance that would restore his $100 if he lost it.A) Harley would be willing to pay more than $25 for this insurance.B) Harley would be willing to pay at most $25 for this insurance.C) Harley would pay at most an amount strictly less than $25 for this insurance.D) Since Harley is risk neutral, he...

You have been sent a bill of $1064. You can choose to pay upfront ($1064) or...

You have been sent a bill of $1064. You can choose to pay upfront ($1064) or pay over 4 installments ($266 for each installment). Given that the company won't charge any interest if you pay before the due date(s), would it be better to pay upfront or over 4 installments?

1. Suppose that a pay equity plan has just been put in place in your organization....

1. Suppose that a pay equity plan has just been put in place in your organization. The pay equity consulting firm did a job evaluation and assigned points to each of the male-dominated and female-dominated jobs. It then estimated the following male and female pay lines by regression, where Y denotes annual earnings, P denotes job evaluation points, and the subscripts m and f denote male and female respectively: Ym = 5000 + 100Pm Yf = 4000 + 80Pf Assume...

Question 3 This grade has been saved to Gradebook. Your answer has been saved and sent...

Question 3 This grade has been saved to Gradebook. Your answer has been saved and sent for grading. See Gradebook for score details. Rogen Corporation manufactures a single product. The standard cost per unit of product is shown below. Direct materials—1 pound plastic at $6.00 per pound $ 6.00 Direct labor—2.5 hours at $11.30 per hour 28.25 Variable manufacturing overhead 17.50 Fixed manufacturing overhead 7.50 Total standard cost per unit $59.25 The predetermined manufacturing overhead rate is $10.00 per direct...

Tanya Williams is the new accounts manager at Southpac Bank. She has just been asked to...

Tanya Williams is the new accounts manager at Southpac Bank. She has just been asked to estimate how many new bank accounts she will generate during the next year. The Australian economy has been growing and the bank has experienced a 10 percent increase in the number of bank accounts over each of the past five years. In the year just ended the bank had 10000 accounts. The new accounts manager is paid a salary plus a bonus of $50...

Tanya Williams is the new accounts manager at Southpac Bank. She has just been asked to...

Tanya Williams is the new accounts manager at Southpac Bank. She has just been asked to estimate how many new bank accounts she will generate during the next year. The Australian economy has been growing and the bank has experienced a 10 per cent increase in the number of bank accounts over each of the past five years. In the year just ended the bank had 10 000 accounts. Page 455 The new accounts manager is paid a salary plus...

Sally works for Nikko Enterprises and earns $990 bi-weekly. She has just received a 2% pay...

Sally works for Nikko Enterprises and earns $990 bi-weekly. She has just received a 2% pay increase, effective this current pay period. In addition, Sally is entitled to five weeks’ vacation pay, which is paid each pay period. Each pay, Sally also receives a group medical benefit of $40, which is shared 50/50 with her employer. She also receives an annual group term life insurance benefit of $1,250. Both plan values include applicable sales tax. In addition, the following are...

You have just been hired as the payroll manager of a mid-sized manufacturing company. You notice...

You have just been hired as the payroll manager of a mid-sized manufacturing company. You notice that the time cards are paper documents that the employee submit at the end of the week into an open cardboard box outside of your office. The time cards contain the employee's name, pay rate, social security number, and division where he/she works. You ask the only employee currently in the payroll department, where the payroll files are and she points you to another...

Subjects