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 state-contingent 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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