Sub part (a):
Diminishing marginal utility .
Sub part (a):
Explanation of Solution
The utility function is
Figure 1 illustrates the diminishing marginal utility.
In Figure 1, the horizontal axis measures the quantity of wealth and the vertical axis measures the utility. When the quantity of wealth increases then the additional utility decreases.
Concept introduction:
Marginal utility: Marginal utility refers to the additional units of satisfaction derived from one more additional unit of goods and services.
Diminishing marginal utility: Diminishing marginal utility refers to a decrease in the additional satisfaction as a result of increasing the consumption.
Sub Part (b):
Expected value.
Sub Part (b):
Explanation of Solution
Since the value is sure, the probability is 1. Expected value of A can be calculated as follows:
Expected value of A is $4,000,000.
Expected value of B can be calculated as follows.
Expected value of B is $4,200,000. Thus, B offers higher value.
Concept introduction:
Risk is the future uncertainty about deviation from expected earnings or expected outcome. Risk measures the uncertainty situation that an investor is willing to take to realize a gain from an investment.
Risk aversion: Risk aversion can be defined as it is a dislike of an uncertainty.
Marginal utility: Marginal utility refers to the additional units of satisfaction derived from one more additional unit of goods and services.
Diminishing marginal utility: Diminishing marginal utility refers to a decrease in the additional satisfaction as a result of increasing the consumption.
Sub part (c):
Expected utility.
Sub part (c):
Explanation of Solution
Expected utility of A can be calculated as follows:
Expected utility of A is $2,000.
Expected utility of B can be calculated as follows.
Expected utility of B is $1,800.
Concept introduction:
Risk is the future uncertainty about deviation from expected earnings or expected outcome. Risk measures the uncertainty situation that an investor is willing to take to realize a gain from an investment.
Risk aversion: Risk aversion can be defined as it is a dislike of an uncertainty.
Marginal utility: Marginal utility refers to the additional units of satisfaction derived from one more additional unit of goods and services.
Diminishing marginal utility: Diminishing marginal utility refers to a decrease in the additional satisfaction as a result of increasing the consumption.
Sub part (d):
greaterExpected utility.
Sub part (d):
Explanation of Solution
Since the expected utility from B is greater than A, the person should select A.
Concept introduction:
Risk is the future uncertainty about deviation from expected earnings or expected outcome. Risk measures the uncertainty situation that an investor is willing to take to realize a gain from an investment.
Risk aversion: Risk aversion can be defined as it is a dislike of an uncertainty.
Marginal utility: Marginal utility refers to the additional units of satisfaction derived from one more additional unit of goods and services.
Diminishing marginal utility: Diminishing marginal utility refers to a decrease in the additional satisfaction as a result of increasing the consumption.
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Chapter 14 Solutions
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