Preferences toward risk, PREFERENCES TOWARD RISK * Choosing Among Risky Alternatives , Microeconomics

Preferences toward risk, Microeconomics

Assignment Help:

PREFERENCES TOWARD RISK

* Choosing Among Risky Alternatives

- Assume

- Consumption of a single commodity

- The consumer knows all probabilities

- Payoffs measured in terms of utility

- Utility function given

* Example

- A person who is earning $15,000 and receiving 13 units of utility from job.

- She is considering a new, but at the same time risky job.

* She has a 50 % chance of increasing her income to $30,000 and a 50% chance of decreasing her income to $10,000.

* She will evaluate the position by calculating expected value of the resulting income.

* The expected value of the new position is the sum of utilities associated with all her possible incomes weighted by probability that each income will occur.

* The expected utility can be given by:

- E(u) = (1/2)u($10,000) + (1/2)u($30,000)

= 0.5(10) + 0.5(18)

= 14

- E(u) of new job is 14 that is greater than current utility of 13 and therefore preferred.

* Different Preferences Toward Risk

- People can be

1) Risk averse

2) Risk neutral or

3) Risk loving

Related Discussions:- Preferences toward risk

Explain decision-making and characteristics of speculative, Consumers purch...

Consumers purchase a house or multiple dwellings for a number of reasons. But what is the rationale behind their decision to buy and/or sell a house, flat or apartment? Do consumer

Micro., what is the theory of second best? prove the theorem with the help ...

what is the theory of second best? prove the theorem with the help of a diagram.

Supply of labour, use a graphical illustration to briefly describe what the...

use a graphical illustration to briefly describe what the influence of an increase in immigrants would be on the market supply of labour

Risk and gambling, John has a utility function given by U(M) = M0.5, where ...

John has a utility function given by U(M) = M0.5, where M represents an amount of cash prize in a game. If John wins, with the probability of 0.2, he will get $900; otherwise, he g