.In attempting to quantify its attitude toward risk, top management of the pharmaceutical company has reported certainty equivalent values for a variety of 50-50 risks. These are summarized in the following table. Outcome of 50-50 Risk Certainty Equivalent $200 and $0 $ 50 $200 and $50 112 $50 and $0 13 $200 and $112 153 $112 and $50 70 $50 and $13 28 $112 and $13 50 For instance, the company's CE for a 50-50 risk between $200 million and $0 is $50 million, and so on. a. Use these responses to determine utility values for each of the monetary valucs in the sccond column. (Hint: Set U($200) = 100 and U($0) = 0. Show that U($50) = 50, U($112) = 75, and so on.) Construct a utility graph by plotting points and drawing a smooth curve. (You may wish to check the utility values in Problem 13 against your curve.) *b. Consider the mathematical utility function U = 7.1Vy, where U is the utility value corresponding to monetary outcome y. Check that this function is an accurate description of the pharmaceutical company's attitude toward risk. Is the company very risk averse?

ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
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Chapter1: Making Economics Decisions
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14. In attempting to quantify its attitude toward risk, top management of the
pharmaceutical company has reported certainty equivalent values for a
variety of 50–50 risks. These are summarized in the following table.
Outcome of 50-50 Risk
Certainty Equivalent
$200 and $0
$ 50
$200 and $50
112
$50 and $0
13
$200 and $112
153
$112 and $50
70
$50 and $13
28
$112 and $13
50
For instance, the company's CE for a 50-50 risk between $200 million
and $0 is $50 million, and so on.
a. Use these responses to determine utility values for each of the monetary
valucs in the sccond column. (Hint: Set U($200) = 100 and U($0) = 0.
Show that U($50) = 50, U($112) = 75, and so on.) Construct a utility
graph by plotting points and drawing a smooth curve. (You may wish to
check the utility values in Problem 13 against your curve.)
*b. Consider the mathematical utility function U = 7.1 Vy, where U is the
utility value corresponding to monetary outcome y. Check that this
function is an accurate description of the pharmaceutical company's
attitude toward risk. Is the company very risk averse?
Transcribed Image Text:14. In attempting to quantify its attitude toward risk, top management of the pharmaceutical company has reported certainty equivalent values for a variety of 50–50 risks. These are summarized in the following table. Outcome of 50-50 Risk Certainty Equivalent $200 and $0 $ 50 $200 and $50 112 $50 and $0 13 $200 and $112 153 $112 and $50 70 $50 and $13 28 $112 and $13 50 For instance, the company's CE for a 50-50 risk between $200 million and $0 is $50 million, and so on. a. Use these responses to determine utility values for each of the monetary valucs in the sccond column. (Hint: Set U($200) = 100 and U($0) = 0. Show that U($50) = 50, U($112) = 75, and so on.) Construct a utility graph by plotting points and drawing a smooth curve. (You may wish to check the utility values in Problem 13 against your curve.) *b. Consider the mathematical utility function U = 7.1 Vy, where U is the utility value corresponding to monetary outcome y. Check that this function is an accurate description of the pharmaceutical company's attitude toward risk. Is the company very risk averse?
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