Question

In: Economics

1. In order to attract customers, Lau's Books Co. is considering offering a lottery to anyone...

1. In order to attract customers, Lau's Books Co. is considering offering a lottery to anyone who visits the bookstore. The 2 lotteries under consideration are:

Lottery A) one with a cash prize of $300 and a 10% probability of winning

Lottery B) one with a cash prize of $400 and a 5% probability of winning.

Which lottery is more attractive to a risk-averse individual? Explain in detail with the aid of a diagram. Which lottery is more attractive to a risk-lover? Explain in detail with the aid of a diagram.

Solutions

Expert Solution

1) A risk averse individual will prefer a certain income to a risky income with the same expected value. A risk averse individual's marginal utility diminishes as income increases.

*So,a risk averse individual will prefer a cash prize of 300 $ with a 10 percent probability of winning.

This can be further explained with the help of the following diagram.

As income increases from Y1 to Y1 utility increases from U1 to U2. When income increases from Y2 to Y3 utility increases from U2 to U3. But the increase in utility is less

BC<AC.

Therefor, utility he derives from lottery with 5 percent probability of winning and 400$ prize will be less than the utility he derives from the lottery with 300$ prize with 10 percent probability of winning.

Since he takes decisions based on utility, he chooses lottery with 300$ cash prize.

2) A risk loving individual will prefer a risky income to a certain income. His marginal utility increases with increase in income.

*A risk loving individual will choose lottery with a cash prize of 400$ dollar and 5 percent probability of winning.

This can be further explained with the help of the following diagram

As income increases from Y1 to Y2. Utility increases from U1 to U2. The addition to utility is represented by AC. When income increases from Y2 to Y3 utility increases from U2 to U3. Addition to utility is represented by BC. Its clear that, additional utility received by the individual increases with increase in income as BC> AC

Therefore, utility he derives from the lottery with a cash prize of 400 $ with 5 percent probability of winning is higher than the utility he derives from the lottery with 300$ cash prize and 10 percent probability of winning.


Related Solutions

An insurance company is considering offering fire insurance to customers in a certain state.
  An insurance company is considering offering fire insurance to customers in a certain state. After examining thousands of records of insurance claims in the area, they have come up with the following information: Payout Number of Claims $58,971 22 28,117 602 0 2,972 First convert the table into a probability distribution by dividing each number in the "Claims" column by the total number of claims. Take probability calculations to 3 decimal places. Now, let X be the expected payout....
1.) Comment on the effectiveness of using deep discounting to attract new customers. What are the...
1.) Comment on the effectiveness of using deep discounting to attract new customers. What are the pros and cons, both in the short-term and long-term? 2.)Once the initial deep discounts have ended, how can Jet.com use other elements in its marketing program to attract and keep customers? Explain
1.) Comment on the effectiveness of using deep discounting to attract new customers. What are the...
1.) Comment on the effectiveness of using deep discounting to attract new customers. What are the pros and cons, both in the short-term and long-term? 2.)Once the initial deep discounts have ended, how can Jet.com use other elements in its marketing program to attract and keep customers? Explain
Monhegan Computers is considering whether to begin offering customers the option to have their old personal...
Monhegan Computers is considering whether to begin offering customers the option to have their old personal computers recycled when they purchase new systems. The recycling system would require Monhegan to invest $650,000 in the grinders and magnets used in the recycling process (that is at t=0). The company estimates that for each system it recycles, it would generate $1.75 in incremental revenues from the sale of scrap metal and plastics. The recycled computers will cost the firm nothing, but it...
Saccomanno Industries Inc. is considering whether to discontinue offering credit to customers who are more than...
Saccomanno Industries Inc. is considering whether to discontinue offering credit to customers who are more than 10 days overdue on repaying the credit extended to them. Current annual credit sales are $10 million on credit terms of "net 30". Such a change in policy is expected to reduce sales by 10 percent, cut the firm's bad-debt losses from 5 to 3 percent, and reduce its average collection period from 72 days to 45 days. The firm's variable cost ratio is...
On January 1, 2017, Fro-Yo Inc. began offering customers a cash rebate of $5.00 if the...
On January 1, 2017, Fro-Yo Inc. began offering customers a cash rebate of $5.00 if the customer mails in 10 proof-of-purchase labels from its frozen yogurt containers. Based on historical experience, the company estimates that 20% of the labels will be redeemed. During 2017, the company sold 5,000,000 frozen yogurt containers at $1, cash, per container. From these sales, 800,000 labels were redeemed in 2017, 150,000 labels were redeemed in 2018, and the remaining labels were never redeemed. Required: 1....
On January 1, 2017, Fro-Yo Inc. began offering customers a cash rebate of $5.00 if the...
On January 1, 2017, Fro-Yo Inc. began offering customers a cash rebate of $5.00 if the customer mails in 10 proof-of-purchase labels from its frozen yogurt containers. Based on historical experience, the company estimates that 20% of the labels will be redeemed. During 2017, the company sold 5,000,000 frozen yogurt containers at $1, cash, per container. From these sales, 800,000 labels were redeemed in 2017, 150,000 labels were redeemed in 2018, and the remaining labels were never redeemed. Required: 1....
On january 1, 2017 , Fro-yo Inc. began offering customers a cash rebate of $5 if...
On january 1, 2017 , Fro-yo Inc. began offering customers a cash rebate of $5 if the customer mails in 10 proof-of purchase labels from its frozen yogurt containers. Based on historical experience , the company estimates that 20% of the labels will be redeemed .During 2017, the company sold 5000000 frozen yogurt containers at $1 cash, per container .From these sales,800000 labels were redeemed in2017,150000 labels were redeemed in 2018, and the remaining labels were redeemed.           Required :...
On January 1, 2017, Fro-Yo Inc. began offering customers a cash rebate of $5.00 if the...
On January 1, 2017, Fro-Yo Inc. began offering customers a cash rebate of $5.00 if the customer mails in 10 proof-of-purchase labels from its frozen yogurt containers. Based on historical experience, the company estimates that 20% of the labels will be redeemed. During 2017, the company sold 5,000,000 frozen yogurt containers at $1, cash, per container. From these sales, 800,000 labels were redeemed in 2017, 150,000 labels were redeemed in 2018, and the remaining labels were never redeemed. Required: 1....
Question 1 The Kingsmill Furniture Company sells its products, offering 30 days’ credit to its customers....
Question 1 The Kingsmill Furniture Company sells its products, offering 30 days’ credit to its customers. Uncollectible amounts are estimated to be equal to 2% of credit sales. At the end of the year, the allowance for doubtful accounts is adjusted based on an aging of accounts receivable. The company began 2017 with the following balances in its accounts: Accounts receivable                $305,000 Allowance for doubtful accounts        (25,500) During 2017, sales on credit were $1,300,000, cash collections from customers were $1,250,000...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT