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Winter 2008 - Newhouse's Class - Exam 1 (Version A)

# Winter 2008 - Newhouse's Class - Exam 1 (Version A) -...

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Economics 171: Decisions Under Uncertainty Midterm 1 – Solutions (Winter 2008) 1. (10 pts) This afternoon it will be either sunny or rainy. Ralph can play on the slide or stay indoors. If he plays on the slide he’ll have fun if it’s sunny and he’ll get hurt if it’s rainy. If he stays indoors he’ll be bored regardless of the weather. a. What actions are available to Ralph? {Play on slide, Stay indoors} b. What states of nature could occur? {Sunny, Rainy} c. What are the possible outcomes? {Have fun, Get hurt, Be bored} 2. (30 pts) Lottery P pays a with probability 0.6 and b with probability 0.4. Lottery Q pays c with probability 0.7 and d with probability 0.3. a. Suppose a = \$10, b = \$50, c = \$20 and d = \$40. (Therefore lottery P is (\$10, 0.6; \$50, 0.4) and lottery Q is (\$20, 0.7; \$40, 0.3).) Which lottery is chosen according to the maximin criterion? Q . The minimum outcome for Q (\$20) is greater than the minimum outcome for P (\$10). b. Ignore the values given for a , b , c and d in part (a). Assume a < b and that c < d . Which lottery is chosen according to the maximin criterion? (You

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Winter 2008 - Newhouse's Class - Exam 1 (Version A) -...

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