Question: Penny is an expected utility maximiser with utility function u(x) = ln(x) and wealth of $300. Paddy makes decisions in accordance with prospect theory,

Penny is an expected utility maximiser with utility function u(x) = ln(x)

Penny is an expected utility maximiser with utility function u(x) = ln(x) and wealth of $300. Paddy makes decisions in accordance with prospect theory, has wealth $300 and value function: X where x 0 (2(-x) = 2 where x < 0 Penny and Paddy are offered the following bet A: a 60% probability to win $150 a 40% probability to lose $100. a) Does Penny or Paddy accept bet A? [3 marks] b) Following some bad economic news, each of Penny and Paddy's wealth declines to $150. Paddy cannot get over the loss, so his reference point remains his former wealth of $300. Penny and Paddy are offered bet A again. Does Penny or Paddy accept the bet? [3 marks] c) For the bets in parts a) and b), draw a diagram (or two diagrams) showing Paddy's value function, the bets and the value of the bets. Explain how the diagram(s) show whether Paddy accepts or rejects the bet. [4 marks] -v(x) = =

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