Question

In: Economics

An individual faces the monetary lottery p. He is made thefollowing offer. For each realization...

An individual faces the monetary lottery p. He is made the following offer. For each realization of the lottery, another lottery (q) will be executed according to which he will win an additional dollar with probability 0.5 and lose a dollar with probability 0.5. Describe the lottery q that he faces. And show that if he is strictly risk averse, he rejects the offer.

Expert Solution

Given that

Expected utility theory and risk aversion

Consider three utility functions:

The consumer is facing 50/50 odds of either receiving $1, or losing $1.

The expected monetary value of this lottery (q) os $ 1/2 or 0.5

As the expected value from lottery is same from all utility function, i.e., 0.5.

If he is risk - averse he rejects the offer,

if L(Z) > ui (L)

Rahul Sunny answered 2 years ago

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