E1)Suppose that Luu's current wealth is $400 and she faces the following lottery. She can earn $500 with probabilityA=1/5, she can earn zero (stay the same) with probabilityB=3/5and she can lose $300 with probabilityC=1/5. Assume Luu's utility function, defined over her wealth, isU(w)=w.What is the expected value of the lottery? (Do not include the initial wealth endowment, only the value of the lottery.)

EV=?

Which utility level would Luu get if she received the expected value of the lottery for sure? (Include Luu's initial wealth endowment.)

U(EV)=?

E2)What is Luu's expected utility (EU)?

EU=?

E3)Why is the utility of the expected value of the lottery different from the expected utility of the lottery?

a)Because Luu is risk-loving

b)Because Luu is risk-neutral

c)Because Luu is risk-averse

E4)What is the guaranteed payoffw, over and above the initial wealth endowment, at which Luu is indifferent between accepting the guaranteed payoff and playing the lottery?

w=?

E5)Assume that Sara's utility function isU(w)=w1/4and that Sara's current wealthwis $400. Finally, assume that Angela's utility function isU(w)=w1/4and that her initial wealth is $1000.

Would Sara derive more or less surplus [utility] from this lottery than Luu?

a)Sara derives more surplus than Luu and will enter the lottery.

b)Sara derives the same surplus as Luu and will enter the lottery.

c)Sara derives the same surplus as Luu and will not enter.

d)Sara derives less surplus than Luu and will not enter.

e)Sara derives more surplus than Luu and will not enter.

f)Sara derives less surplus than Luu and will enter the lottery.

E6)Would Angela derive more or less surplus from this lottery than Luu?

a)Angela derives more surplus than Luu and will enter the lottery.

b)Angela derives the same surplus as Luu and will not enter.

c)Angela derives less surplus than Luu and will enter the lottery.

d)Angela derives more surplus than Luu and will not enter.

e)Angela derives less surplus than Luu and will not enter.

f)Angela derives the same surplus as Luu and will enter the lottery.

E7)Which kind of people do we expect to have a higher propensity to enter this kind of lottery?(More than one answer can be right)

(Select each correct answer.)

a)People who are risk-averse

b)People who are risk-loving

c)People who have high initial wealth

d)People who have low initial wealth

e)None of the above