Paul is an expected utility maximizer. Consider the following lotteries:

• A: A chance of winning $5,000 for sure

• B: A chance of winning $3,000 with probability 40% and $6,000 with probability 60%

• C: A chance of winning $3,000 for sure

• D: A chance of winning $600 with probability 50% and $5,000 with probability 50%

Paul is indifferent between A and B and indifferent between C and D. This does not mean that he is indifferent between A and C or between B or D (5 points each).

a) Is Paul risk-averse, risk-neutral or risk-loving? Explain.

b) Paul is presented with the following two lotteries. Will Paul prefer E to F, prefer F to E, be indifferent between the two, or is the answer intermediate? Explain.

• E: A chance of winning $3,000 for probability 40%, $6,000 with probability 60% (Note: lottery E is the same as lottery B)

• F: A chance of winning $1,500 with probability 40% and $7,000 with probability 60%

c) Paul is presented with the following two lotteries. Will Paul prefer G to H, prefer H to G, be indifferent between the two, or is the answer intermediate? Explain.

• G: A change of winning $4,000 for sure

• H: A chance of winning $600 for probability 25%, $3,000 with probability 20%, $5,000 with probability, $6,000 with probability 30%

Answer rating: 100% (QA)

a Paul is riskloving Because Paul is indifferent between lottery having lower weighted average and v... View the full answer