Currently earning an income

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Reference no: EM13912293

Suppose that John is currently earning an income of $10,000 (I = 10) and can earn that income next year with certainty. He is offered a chance to take a new job that offers a .5 probability of earning $16,000, and a .5 probability of earning $5,000.

1) Should he take the new job if is a risk neutral agent?

2) Suppose that in fact his utility function is u(y) = y0.5. Should he take the new job? Is John risk loving, risk neutral, or risk averse?

3) Would John be willing to buy insurance to protect against the variable income associated with the new job? If so, how much would he be willing to pay for that insurance? (Hint: What is the risk premium?)

4) According to Prospect Theory explain how John will make a decision?

Reference no: EM13912293

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