Question

Explain the difference between a risk averse decision maker and a risk seeking decision maker. Draw graphs to support your answer.

Answer 1

The risk seeking individuals recogonize the established link between the risk and return. They usually seeks for a very high return and accepts the high risk associated with it. This attitude can be seen in an entrepreneur who plans to set up a business in the hope of becoming a millionaire. In order to achieve this he may take the bank loan and put his all assets in to risk. The risk taking decision maker should have an increasing marginal utility, as his wealth increases his marginal utility rise at an increasing rate.

The risk averse decision maker is concerned with limiting his risk, in the extreme level he takes an extra cautious approach to limit his risk. Normally a risk averse decision maker accepts a lower return that is normally company gives with the low risk level. The risk aversion describes the way that the rational people makes the decisons. The rational people always been risk averse.

The pane A shows the risk averse decison maker and the panel A shows the risk loving decision maker. In panel A, as his wealth increases the utility also increases but it is ina dimnishing rate. In the panel B shows the risk loving decision maker, from that we can see that as his wealth increases the utility rises at a increasing rate.