Question

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1. Kascade is a DJ and has a large collection of records worth $10,000. He has a cat called

Jazz whom he loves dearly. Kascade knows that with probability 0.2 Jazz will scratch his records and will damage his collection. If this occurs the value of his collection will be reduced to $2,500.

Kascade’s attitude toward risk is characterized by u(M )= M , where M is hisr wealth level as represented by the value of the collection.

Suppose instead that Megan offers Kascade the following arrangement: if Kascade pays her $P, then in the event that Jazz damages his collection, she will pay him for the damage; and if Jazz does not damage his collection, she will pay him nothing. Megan’s utility function is with respect to wealth is givenbyu(M)=M .

c) Will both Kascade and Megan benefit from this arrangement? Explain your answer.

Answer 1

Here capital P = The amount Kascade pays Megan

lowercase p = The proabability of Jazz scratching Kascade's records

All questions have been answered below.