Question: You wish to construct your personal utility function U(M) for receiving M thousand dollars. After setting U(0) = 0, you next set U(10) = 1

You wish to construct your personal utility function U(M) for receiving M thousand dollars. After setting U(0) =

0, you next set U(10) = 1 as your utility for receiving

$10,000. You next want to find U(1) and then U(5).

a. You offer yourself the following two hypothetical alternatives:

A1: Obtain $10,000 with probability p.

Obtain 0 with probability (1 − p).

A2: Definitely obtain $1,000.

b. You then ask yourself the question: What value of p makes you indifferent between these two alternatives? Your answer is p = 0.125. Find U(1) by using the equivalent lottery method.

c. You next repeat part a except for changing the second alternative to definitely receiving $5,000.

The value of p that makes you indifferent between these two alternatives now is p =

0.5625. Find U(5).

d. Repeat parts a and

b, but now use your personal choices for p.

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