Define the risk premium p = ċ – Cce where c = TCH + (1 – T)CL is the expectedlevel of consumption from the lottery (7 = E[c]). Consider the following exercise.There are three lotteries characterized by different probabilities of obtaining cH-Let these probabilities be given by a" > T' > n. Using a single diagram, plot therisk premium for each of these three lotteries. Does the risk premium increase or-decrease as we increase across these three lotteries? Provide the intuition foryour result. Consider the lottery that assigns a probability of obtaining a level of consumption Chand a probability 1-7 of obtaining a low level of consumption c1 with cH > CL. Consideran individual facing such a lottery with utility function u(c) that has the properties thatmore is better (that is, a strictly positive marginal utility of consumption at all levels ofc) and diminishing marginal utility of consumption, u"(c) < 0. As usual, we are usingfor the first derivative of the utility function with respect todu(c)dcdu(c)dc2the shorthand u'(c)du' (c)consumption and u" (c)(which is also the derivative of the first derivative of the utility function).to be the second derivative of the utility functiondc

Risk premium is the amount which a consumer is willing to pay in order to avoid a risky event . RP…

Define the risk premium p = č - Cce where č level of consumption from the lottery (7 = E[c]). Consider the following exercise. There are three lotteries characterized by different probabilities of obtaining CH. Let these probabilities be given by r" > T' > T. Using a single diagram, plot the risk premium for each of these three lotteries. Does the risk premium increase or = TCH + (1 – T)CL is the expected decrease as we increase T across these three lotteries? Provide the intuition for your result.

Define the risk premium p = č - Cce where č level of consumption from the lottery (7 = E[c]). Consider the following exercise. There are three lotteries characterized by different probabilities of obtaining CH. Let these probabilities be given by r" > T' > T. Using a single diagram, plot the risk premium for each of these three lotteries. Does the risk premium increase or = TCH + (1 – T)CL is the expected decrease as we increase T across these three lotteries? Provide the intuition for your result.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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