a. Consider a person with an initial wealth level of 100 who faces a chance to w

Question

a. Consider a person with an initial wealth level of 100 who faces a chance to win 20 with probability ½ and to lose 20 with probability ½. If this person’s utility function is given by U(M) = M2, will she accept the gamble?

b. Consider a person with an initial wealth level of 100 who faces a chance to win 20 with probability ½ and to lose 20 with probability ½. If this person’s utility function is given by U(M) = M, will he accept the gamble?

c. Consider a person with an initial wealth level of 100 who faces a chance to win 20 with probability ½ and to lose 20 with probability ½. If this person’s utility function is given by U(M) = M1/2, will it accept the gamble?

Explanation / Answer

None of the persons will accept the gamble because winning probability and losing probability are the same. They rather prefer being indifferent.

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