Question: Suppose that your utility function is u (x) = x, and that you are offered a gamble which allows you to win $16 if you

Suppose that your utility function is u (x) = √x, and that you are offered a gamble which allows you to win $16 if you are lucky and $4 if you are not.

(a) Suppose that the probability of winning $16 is 1/4 and the probability of winning $4 is 3/4. What is the expected utility of this gamble?

(b) Suppose that the probability of winning $16 is still 1/4 and the probability of winning $4 is 3/4. What is the certainty equivalent of the gamble?

(c) Imagine now that the probability of winning $16 is p and the probability of winning $4 is (1 – p). If the expected utility of the gamble equals 9/4, what is p?

(d) Are you risk averse or risk prone, given the utility function above?

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