171 M2-1

171 M2-1 - Economics 171: Decisions Under Uncertainty...

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Unformatted text preview: Economics 171: Decisions Under Uncertainty Solutions to Midterm 2 Spring 2008 1. (25 pts) Joes utility function is where a u x a = . (Your answers for this question may be in terms of a and b .) a. Calculate Joes coefficient of absolute risk aversion. ( 29 ( 29 ( 29 ( 29 1 2 2 1 1 1 ' , '' 1 1 '' 1 1 ' a a a a u ax u a a x a a x u a x a x u ax ------ = =-- = - = - = -- =- b. For what values of a will Joe be risk averse? He will be risk averse whenever > 0. ( 29 1 1 1 a x a - =- < (We can also get this result by finding when u is concave.) c. Find Joes certainty equivalent for lottery p = ($1, 0.6; $ 1 20 a , 0.4). ( 29 ( 29 1 1 0.6 1 0.4 20 8.6 8.6 a a a a a a u x EU p x x x = = + = = d. Find Joes risk premium for lottery p = ($1, 0.6; $ 1 20 a , 0.4). ( 29 ( 29 ( 29 ( 29 ( 29 1 1 1 1 0.6 1 0.4 20 0.6 0.4 20 0.6 0.4 20 8.6 a a a a E p R p E p CE p = + = + =- = +- e. Lisas utility function is where b u x b = . Lisa is at least as risk averse as Joe. Whats the most that can be said about the relationship between a and b ....
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This note was uploaded on 06/08/2010 for the course ECON 171 taught by Professor Newhouse during the Spring '07 term at UCSD.

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171 M2-1 - Economics 171: Decisions Under Uncertainty...

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