2. Consider an expected utility maximizing risk-averse individual with the utility-of- wealth function u(w) and initial wealth wo. There is a lottery that pays G with probability p and B with probability 1 -P, with G> B. (a) Suppose the individual already owns the ticket to this lottery, in addition to her initial wealth. Find an equation that implicitly defines the smallest price P, such that she would be willing to sell the ticket for this price. (b) Now suppose she does not initially own the ticket, and has to consider whether to buy one. Find an equation that implicitly defines the highest price P, that she would be willing to pay to buy the ticket. (c) Calculate P, and P, if the individual's utility function of his final wealth w is u(w) = √w, and G = 10, B = 0, wo = 10, and p = 0.5.

2. Consider an expected utility maximizing risk-averse individual with the utility-of- wealth function u(w) and initial wealth wo. There is a lottery that pays G with probability p and B with probability 1 -P, with G> B. (a) Suppose the individual already owns the ticket to this lottery, in addition to her initial wealth. Find an equation that implicitly defines the smallest price P, such that she would be willing to sell the ticket for this price. (b) Now suppose she does not initially own the ticket, and has to consider whether to buy one. Find an equation that implicitly defines the highest price P, that she would be willing to pay to buy the ticket. (c) Calculate P, and P, if the individual's utility function of his final wealth w is u(w) = √w, and G = 10, B = 0, wo = 10, and p = 0.5.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.5P

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