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as372f08a1 - ActSc 372 FALL 2008 Assignment 1 Due Date(in...

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ActSc 372 FALL 2008 Assignment 1 Due Date: September 26, 2008 (in class 2:30pm) 1. Suppose you are an expected utility maximizer with utility of wealth u ( w ) = w, w > 0. What is the maximum amount you are willing to pay to participate in the coin tossing gamble as described in the St Petersburg Paradox? 2. Suppose you are asked to choose between the following two gambles: 1A: Winning $1 million with certainty, or 1B: A 89% chance of winning $1 million, 10% chance of winning $5 million and 1% chance of winning nothing. You are then asked to choose between gambles 2A and 2B: 2A: A 11% chance of winning $1 million and a 89% chance of winning nothing, or 2B: A 10% chance of winning $5 million and a 90% chance of winning nothing. (a) If you are an expected value maximizer, which gamble would you choose between 1A and 1B? What about between 2A and 2B? (b) Presented with the choice between 1A and 1B, most people choose 1A. Presented with the choice between 2A and 2B, most people choose 2B. If you are an indi- vidual who makes these choices (i.e. chooses 1A and 2B), then demonstrate that
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