Intermediate Microeconomics, 2008
Problem Set No 7
due: Monday, Feb 4;
Tuesday, Feb 5
Problems
Please, answer the following questions in the book.
Chapter 5, Question 20, 30,
Chapter 16, Question 4, 8, 14 (Note: You don°t need to use a decision tree
to answer problem 8).
1) The graphic below shows the preferences of two persons over bets.
a) Who do you think puts a higher subjective probability on Tiger winning?
b) Can you draw the indi/erence curves for the case that the decision make
is certain that Tiger will win?
2) The graphic below shows the preferences of two persons over bets. Who
do you think is more risk averse?
Can you ±nd the the certainty equivalent
for the bet (1,3)? (Certainty equivalent: Suppose you can choose between the
bet (x,y) and an amount $M for sure. The certainty equivalent of (x,y) is the
amount $M that makes you exactly indi/erent between the bet (x,y) and the
money $M.)
1
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3) Consider the following bets on Donkey and Tiger:
A=(1,3),B=(5,5),
C=(10,0), D=(6,4)
a) Calculate the variance and the expected value of the bets, if the probability
that Tiger wins is
°
= 0
:
5
.
b) Suppose a decision maker has a utility function for money given by
u
(
x
) =
p
x
. If she believes that Donkey and Tiger are equally likely to win, how will
she rank the bets?
c) Calculate for each bet the certainty equivalent.
d) Suppose the utility function of the decision maker is
u
(
x
) = 7
x
. How will
she decide now? How will she decide if it is
u
(
x
) = 6
x
+ 1
? Can you explain
you ±nding?
e) Suppose the utility function of the decision maker is
u
(
x
) =
x
2
. How will
she decide now? Can you explain you ±nding?
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 Winter '08
 Burbidge,John
 Microeconomics

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