1. Jerry has wealth of $60 and derives utility from this according to the utility function U(w) = 1 - , Where w is his wealth. Jerry now finds a lottery ticket (whose drawing is tomorrow) that offers a 50% chance of winning $5. (a) What is the expected value of the lottery ticket? (b) What is the minimum amount for which Jerry would be willing-to-sell the ticket? (c) Which is bigger, your answer to (a) or (b)? Use a clearly labelled diagram to explain why. (d) If he does not sell the ticket, what is Jerry's cost of risk?
1. Jerry has wealth of $60 and derives utility from this according to the utility function U(w) = 1 - , Where w is his wealth. Jerry now finds a lottery ticket (whose drawing is tomorrow) that offers a 50% chance of winning $5. (a) What is the expected value of the lottery ticket? (b) What is the minimum amount for which Jerry would be willing-to-sell the ticket? (c) Which is bigger, your answer to (a) or (b)? Use a clearly labelled diagram to explain why. (d) If he does not sell the ticket, what is Jerry's cost of risk?
Chapter7: Uncertainty
Section: Chapter Questions
Problem 7.7P
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Transcribed Image Text:1. Jerry has wealth of $60 and derives utility from this according to the utility function
U(w) = 1 - -,
Where w is his wealth. Jerry now finds a lottery ticket (whose drawing is tomorrow)
that offers a 50% chance of winning $5.
(a) What is the expected value of the lottery ticket?
(b) What is the minimum amount for which Jerry would be willing-to-sell the ticket?
(c) Which is bigger, your answer to (a) or (b)? Use a clearly labelled diagram to
explain why.
(d) If he does not sell the ticket, what is Jerry's cost of risk?
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