Question

3. Consider the following gamble: 80% $4,000 1000 20% $3,000 $0 20% $4,000 25% $3,000 80% 75% $0 $0 Most people choose the top right gamble over the top left, and the bottom left over the bottom right. (a) Show that this pair of choices is inconsistent with expected utility maximization. (b) Discuss what might be happening to cause the choices.

Answer 1

Answer Given data Soly 84,000 $3,000 zoy, so 83,6 $3,000 201, 84,000 251 80). So 75% $0 a Top right Top right gamble preffered over Top lefs. 9 801. 24, - $ 3,000 $0 (Top right) 204. (Topleft) It is incosistent with expected utility thoorm because payoff from top left is- To Set Cucoso ) + 2006). 280 Cuo) T : 3200 "To poxoff 3200 as greater than 3000 but still rejected. According to expected etility theorem. The top left having greater payoff must selected

207, 4000 251, $3,000 25., O < as preferred to sono Pottom left pay off. Tal - 20 (4coo) + SO (O). 100 100 20x40 sco. Bottom right payoff Age Sic (3000) + 75/1c0(0), 25x30 - 750 bettem left According to expected utility Should have been choosen at was consistent CD consumer as that might be risk overse and he looks to amount of payoff rather than having wholesome thought. In this case be choose top right give him sooo with certain. consumen hat risk averse natue : soi th bottom case action is consistent