Afternoon Exam solutions

Some of them have initial wealth values in the region

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Unformatted text preview: are risk averse for wealth values below a certain level and risk seeking for wealth values above this level. a. (5 minutes) Draw the Bernoulli utility function of the individuals described above in a graph with wealth on the x ­axis and utility on the y ­axis. Utility W* Wealth b. (4 minutes) Would someone with such a Bernoulli utility function ever choose to simultaneously purchase insurance policies with positive loads and purchase lottery tickets with negative expected payments? Justify. Yes. Since the individual is risk averse for low values of wealth and risk seeking for high values of wealth, he/she may like to buy insurance against large losses (since the wealth would fall in the risk averse region) and may still like to purchase lottery tickets (because wealth would fall in the risk seeking region).  ­ 5  ­ c. (5 minutes) Consider a society populated by individuals with the Bernoulli utility function suggested by Friedman and Savage, but with different initial wealth values. Some of them have initial wealth values in the region of risk aversion and others are in the risk ­seeking region. Every individual has the opportunity to start a new business. The profit from the new business is random and has mean zero. Would any of the individuals prefer to start the new business? If so, who? Yes. Those with initial wealth in the risk seeking region would prefer to start the new business since they prefer a gamble to a sure outcome with the...
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