1. The expected value of a gamble Daesun and Kim are friends who are attending a

Question

1. The expected value of a gamble Daesun and Kim are friends who are attending a "casino night" at a charity fundraiser. Once inside, there's a table at which you can gamble: For $5, you can flip a coin. If it comes up heads, you get $8 back, for a gain of $3. If it comes up tails, you get $4 back, for a loss of $1. For all parts of this question,assume that, if you are indifferent between taking the gamble and not taking it, you will take the gamble. This game is Suppose Kim decides not to take the gamble. Can you conclude from this that she is risk averse? O No Yes Suppose Daesun decides to take the gamble. Suppose a different table offers another $5 coin flip where heads pays $6 and tails pays $4. Can you conclude that he would also accept this gamble? O Yes O No

Explanation / Answer

This game is a profitable one since there is a higher probability of earning more expected money.

E(x) = PxE1 + PyE2  =

E(x) = 3(1/2) - 1(1/2)

E(X) = $1

Yes, she is risk averse. Because there is a higher expected return in this case as has been observed from the calculations above.

No. We cannot conclude if he will accept the gamble. Because the expected gain, in this case, would be 1(1/2) - 1 (1/2) = 0  

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