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A decision-maker must choose between two lotteries, L₁ and L2. The lottery L₁ gives 0 dollars with probability 1/4 and 20 dollars with probability 3/4, whereas L2 gives 12 dollars for sure. The decision-maker is an expected utility maximizer with utility u(w), where w is the change in the consumers wealth. Assume that u(-) is continuous and strictly increasing. (a) Suppose that the decision-maker is risk averse. Can you determine which lottery she will choose? (b) Suppose that someone who knows the outcome of the lottery L₁ is willing to sell the information to the decision-maker. If the decision-maker is risk neutral, how much would she be willing to pay to know the outcome of lottery L₁ before making her choice between L₁ and L₂? (c) Suppose that the decision-maker is risk loving and, as in (b), she can buy information about the outcome of lottery L₁ prior to making her choice between L₁ and L₂. Is she willing to pay a positive amount to know the outcome of the lottery?

A decision-maker must choose between two lotteries, L₁ and L2. The lottery L₁ gives 0 dollars with probability 1/4 and 20 dollars with probability 3/4, whereas L2 gives 12 dollars for sure. The decision-maker is an expected utility maximizer with utility u(w), where w is the change in the consumers wealth. Assume that u(-) is continuous and strictly increasing. (a) Suppose that the decision-maker is risk averse. Can you determine which lottery she will choose? (b) Suppose that someone who knows the outcome of the lottery L₁ is willing to sell the information to the decision-maker. If the decision-maker is risk neutral, how much would she be willing to pay to know the outcome of lottery L₁ before making her choice between L₁ and L₂? (c) Suppose that the decision-maker is risk loving and, as in (b), she can buy information about the outcome of lottery L₁ prior to making her choice between L₁ and L₂. Is she willing to pay a positive amount to know the outcome of the lottery?

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
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4. A decision-maker must choose between two lotteries, L₁ and L2. The lottery L₁ gives 0 dollars with probability 1/4 and 20 dollars with probability 3/4, whereas L2 gives 12 dollars for sure. The decision-maker is an expected utility maximizer with utility u(w), where w is the change in the consumers wealth. Assume that u(-) is continuous and strictly increasing. (a) Suppose that the decision-maker is risk averse. Can you determine which lottery she will choose? (b) Suppose that someone who knows the outcome of the lottery L₁ is willing to sell the information to the decision-maker. If the decision-maker is risk neutral, how much would she be willing to pay to know the outcome of lottery L₁ before making her choice between L₁ and L2? (c) Suppose that the decision-maker is risk loving and, as in (b), she can buy information about the outcome of lottery L₁ prior to making her choice between L₁ and L₂. Is she willing to pay a positive amount to know the outcome of the lottery?
Transcribed Image Text:4. A decision-maker must choose between two lotteries, L₁ and L2. The lottery L₁ gives 0 dollars with probability 1/4 and 20 dollars with probability 3/4, whereas L2 gives 12 dollars for sure. The decision-maker is an expected utility maximizer with utility u(w), where w is the change in the consumers wealth. Assume that u(-) is continuous and strictly increasing. (a) Suppose that the decision-maker is risk averse. Can you determine which lottery she will choose? (b) Suppose that someone who knows the outcome of the lottery L₁ is willing to sell the information to the decision-maker. If the decision-maker is risk neutral, how much would she be willing to pay to know the outcome of lottery L₁ before making her choice between L₁ and L2? (c) Suppose that the decision-maker is risk loving and, as in (b), she can buy information about the outcome of lottery L₁ prior to making her choice between L₁ and L₂. Is she willing to pay a positive amount to know the outcome of the lottery?
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