171 M2-4

# 171 M2-4 - Economics 171 Decisions Under Uncertainty...

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Economics 171: Decisions Under Uncertainty Solutions to Midterm 2: Spring 2009 1. (24 pts) Rick’s utility function is  1 2 4 ux x . a. Calculate Rick’s coefficient of absolute risk aversion. 1 2 3 2 3 2 1 2 '2 '' 1 2 x x x x x x  b. Find Rick’s certainty equivalent for lottery p = (\$16, 0.25; \$64, 0.75). 1 11 2 22 1 2 4 0.25 4 16 0.75 4 64 42 8 49 x EU p x x     c. Find Rick’s risk premium for lottery p = (\$16, 0.25; \$64, 0.75).         0.25 16 0.75 64 52 52 49 3 Ep Rp Ep C  d. The absolute value of Laura’s coefficient of absolute risk aversion is strictly greater than the absolute value of Rick’s (for all values of x ). What’s the most that can be said about her attitude towards risk (risk- averse, risk-neutral, risk-loving, or some specific combination of these)? Laura’s coefficient could be positive or negative but not zero. She could be either risk-averse or risk-loving.

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2. (21 pts) Lottery A = (\$35, 1). Lottery B = (\$20, 0.25; \$40, 0.75) a. Clearly show or explain why B is a mean preserving spread of A . E(A) = 1(35) = 35 = 0.25(20) + 0.75(40) = E(B) (This holds for all parts of this problem.) 0.25 of the mass is pushed left to \$20 and 0.75 is pushed right to \$40.
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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 M2-4 - Economics 171 Decisions Under Uncertainty...

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