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Microeconomic Theory II
Problem set on Uncertainty
Question 1
Sarah preference is described by utility U = W
1/2
, where W is here wealth level. She is
facing a possible loss of her car worth $1000 with probability 0.1. Suppose that an
insurance company will charge 11 cents per one dollar of insurance bought. Let her
initial wealth level be $10000. Will she buy any insurance and if so how much? Also,
depict your result on a diagram with statecontingent consumption as your axes.
Question 2
Connie’s utility depends upon her income. Her utility function is U=I
1/2
. She has
received a prize that depends on the roll of a pair of dice. If she rolls a 3, 4, 6 or 8, she
will receive $400. Otherwise she will receive $100.
a)
What is the expected payoff from this prize? [ The probability of rolling a 3 is
1/18, the probability of rolling a 4 is 3/36, the probability of rolling a 6 is 5/36,
and the probability of rolling an 8 is 5/36]
b)
What is the expected utility from this prize?
c)
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 Spring '10
 YY
 Microeconomics, Utility

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