ps3 - Collin Cudd AAE 474 PS3 1 a The safety first...

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Collin Cudd AAE 474 PS3 1) a) The safety first hypothesis says that people will eliminate all choices where the probability of disaster is greater than the maximum level of risk they are willing to take. In this case the maximum level of risk the household is willing to take is a 5% chance of income dropping below 600. The household will therefore allocate 11.2% of the land to broccoli and the remaining 98.8% to maize. This allocation will give them an expected income of 680; this is the greatest expected income they can achieve without exceeding an acceptable level of risk. b) The expected utility hypothesis says that households make decisions in order to maximize expected utility. The option resulting in the highest expected utility will therefore be the option chosen. In our example the greatest expected utility comes from allocating 41% of the land to broccoli. This allocation yields an expected utility of 100.141, an expected income of 736 and has a 29% chance of disaster. c) A risk neutral household would simply choose to maximize expected income. In this instance the household devotes all of its 2.2 hectare to broccoli resulting in an expected income of 843. 2) a) In the absence of methods to smooth a households income such as savings, credit or insurance, the safety first model is the best approach. The safety first approach acts as a mechanism to smooth income by keeping risk at a relatively low level.
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