Consider an agent with the following utility function:%3Dwhere o ("sigma") is a parameter that we fix and does not vary.(a) For which values of o is the agent risk averse? (hint: use the mathematical definition of risk aversion)(b) Compute the coefficient of absolute risk aversion and relative risk aversion. How do they vary with x?Consider the case where o = 2 and the lottery L that pays $ 3, $ 5 and $ 10 with equal probability. The agent hasan initial wealth of $ 6. In order to participate to this lottery, the agent has to pay an amount of dollars p.(c) Let p = 3. Does the agent prefer to participate to the lottery or not participate?(d) What is the amount of dollars you should give the agent so that he is indifferent between participating to thelottery and not participating but getting the money?

"risk aversion" refers back to the preference of individuals to keep away from uncertainty or…

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ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

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Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Concept explainers

Comparative Advantage and Absolute Advantage Analysis

The theory of absolute advantage was given by Adam Smith in the year 1776.

Question

Consider an agent with the following utility function:
%3D
where o ("sigma") is a parameter that we fix and does not vary.
(a) For which values of o is the agent risk averse? (hint: use the mathematical definition of risk aversion)
(b) Compute the coefficient of absolute risk aversion and relative risk aversion. How do they vary with x?
Consider the case where o = 2 and the lottery L that pays $ 3, $ 5 and $ 10 with equal probability. The agent has
an initial wealth of $ 6. In order to participate to this lottery, the agent has to pay an amount of dollars p.
(c) Let p = 3. Does the agent prefer to participate to the lottery or not participate?
(d) What is the amount of dollars you should give the agent so that he is indifferent between participating to the
lottery and not participating but getting the money?

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Step 1: Define risk aversion

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Step 2: Explain the values of o that is the agent risk averse

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Step 3: Compute the coefficient

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Step 4: Explain whether the agent prefers to participate in the lottery

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Step 5: Compute the required values

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