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ps4fall200_201

# ps4fall200_201 - 14.03 Problem Set#4 Fall 2000 Due in...

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14.03 Problem Set #4 Fall 2000 Due in Class #14 Theory 1. Nicholson problem 8.5 2. Bill is a Von-Neumann Morgenstern expected utility maximizer with a well-behaved, continuously differentiable utility function (i.e., no kinks or inflection points). Bill is presented with the following choices: A. \$1,000 for sure B. 50% chance of \$800 50% chance of \$1,500 C. \$500 for sure D. 50% chance of \$400 50% chance of \$900 Bill is indifferent between A and B and is also indifferent between C and D. (Note: this does not imply that he is indifferent between A and C or B and D.) Part 1 . Is Bill risk neutral, risk averse, risk loving, or can’t you tell? Explain. He is now faced with the following choice: E. \$750 for sure F. 25% chance of \$400 25% chance of \$900 25% chance of \$800 25% chance of \$1,500 Part 2 . Will Bill choose E or F, or is he indifferent between them, or is not possible to tell? (You must prove your answer) 3. Consider these four choices: A. \$1,000,000 for sure B. .10 chance of \$5,000,000 .89 chance of \$1,000,000 .01 chance of \$0 1

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C. .10 chance of \$5,000,000 .90 chance of \$0 D. .11 chance of \$1,000,000 .89 chance of \$0 Before reading any further, choose which you prefer between A and B, and then choose which you would prefer between C and D. (The choice you make will not affect your grade.)
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