Use the diagram below to answer the following questions. Assume that utility lev

Question

Use the diagram below to answer the following questions. Assume that utility levels run and income ranges from 0 to 5 thousand. Assume that income has two possible outcomes, $5000. Each outcome has a .5 chance of occurring. from 0 to 3 utils S1000 and Figure 1: Utility function 19. Given the shape of the utility function in Figure 1, we could say that an economic agent would be when evaluating events with uncertain outcomes. a. risk preferring, b. risk neutral, c. risk averse 20. In figure 1, the agent's expected utility function is represented by line segment a. ABC b. ADC c. AD d. 21. In figure 1, the level of the agent's expected utility is given by poirnt 22. In figure 1, what is the utility value of the Certainty Equivalent of expected utility? a. 0 b.1 c.2 d. 3 23. From the information above derive the expected value and variance of income. If the RAC coefficient is 0.0001, what would be the level of the risk premium the agent would require to participate in this opportunity? a. 4,000,000 b. 44.72 c. 400 d. 4,000

Explanation / Answer

21. Expected utility is corresponding to expected income

Exp. income = 0.5*1000 + 0.5*5000 = $3000 => Expected utility (on line ADC) = Point D [Answer]

22. [Answer c] - Utility level = 2

23. Expected value of income = $3000 (level = 3) and variance = 8,000,000 (8). RAC = 0.0001 => Answer: 400 (c)

25. Beta = -0.5 (approximately) => determined by the slope of change in utility (Y) when income (X) changes

28. [Answer d] - it is risk vs return study => Expected risks and Expected returns

29. [Answer a] - Highest potential outcome => Highest returns => Max-Max rule

30. [Answer d] - Maximum average gain => Go for best expected outcome => Expected Value rule

31. [Answer c] - Negatively correlated

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