In: Economics
CHOICE UNDER UNCERTAINTY
III. Consider an individual with an initial wealth of $50,000. They have the opportunity to
invest in a project where they may win $40,000 with a probability of 0.8 and may lose
$40,000 with a probability of 0.2. There are no out-of-pocket costs for investing in the
project but if they lose then that will be deducted from their initial wealth.
1. What would be the individual’s expected wealth if they participate in the investment
project?
2. If the individual’s preference towards risk are defined by the function: ? = √?, would
they invest in the project? (Hint: Calculate the expected utility of wealth if the individual
participates in the investment and compare it with the utility of their current wealth)