In: Economics
Matt has waited a long time for her truck to come in. He thinks that it will come today with a 1/4 probability. If it comes, he will receive $1600. If it doesn't come today, it never will and he will have zero wealth.
He has a Bernoulli utility function equal to the square root of his total income. (bernoulli utility function = (total income)^(1/2)
What is the minimum price at which he would sell the rights to his truck?
U = √w
w : income
EU = .25*√1600 + .75√0
= .25*40
= 10
So, Certainty Equivalent, CE
U(CE) = EU
√CE = 10
CE = 100
Thus Minimum price, so that expected utility is unchanged
Is $ 100