a) In decision-making under uncertainty, explain why “expected utility” is preferred to “expected value” in consumer’s...

a) In decision-making under uncertainty, explain why “expected utility” is preferred to “expected value” in consumer’s optimization. Describe a situation where maximizing “expected utility” and maximizing “expected value” are equivalent.

b) An individual has a utility function represented by ?(?) = √? , where I is her annual income in dollars.

(i) Is this individual risk loving, risk neutral or risk averse?

(ii) Suppose this individual has a current disposable income of $90,000. Suppose that there is a one percent (1%) chance that her house may burn down, and if it does, the cost of repairing it will be $80,000, thereby reducing her disposable income to $10,000. Calculate the expected value (income) and expected utility for this individual.

(iii) The individual is offered insurance to protect against the possibility of a fire. What would be a fair insurance premium? If the individual takes up the insurance, what is the maximum amount she would be willing to pay for this insurance?

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Expert Solution

Rahul Sunny answered 1 year ago

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