Risk aversion and indifference curve, Microeconomics

Assignment Help:

Risk Aversion and Income

- Variability in potential payoffs increases risk premium.

- Example:

  • A job has a .5% probability of paying $40,000 (utility of 20) and a 5 percent chance of paying 0 (utility of 0).

* The expected income is $20,000, but expected utility falls to 10.

Expected utility = .5u($) + .5u($40,000)

         = 0 + .5(20) = 10

* The certain income of $20,000 has a utility of 16.

*  If person is required to take the new position, the utility of them will fall by 6.

* The risk premium is $10,000 (that is they would be willing to give up $10,000 of the $20,000 and have same E(u) as the risky job.

*  Thus, it can be said that greater the variability, greater the risk premium.

*  Indifference Curve

- Combinations of the3 expected income & standard deviation of income which yield the same utility.

1808_risk aversion.png

2239_risk aversion1.png


Related Discussions:- Risk aversion and indifference curve

Roger, What would be a factor that would make the prospects hopeful for ove...

What would be a factor that would make the prospects hopeful for overcoming the demand for resources in the future

Economic theory, How economic theory explain optimum pattern of consumption...

How economic theory explain optimum pattern of consumption for an individual consumer

Law of diminishing marginal utility, law of diminishing marginal utility it...

law of diminishing marginal utility its assumptions, limitation, and its practical importance

Matter and the three basic states, how can I execute this topic in new way ...

how can I execute this topic in new way of teaching? That will focus on activity base and art of questioning that will answer by the students?

Protec tionism and free trade, what is the south africas governments standp...

what is the south africas governments standpoint on international trade

What is black economy, Defining black economy, If you pay your cleaner or ...

Defining black economy, If you pay your cleaner or builder in cash or for some reason neglect to tell the taxman which you were paid for a service rendered, you participate in the

Balance of payments and developing economies, Balance of Payments and Devel...

Balance of Payments and Developing Economies: It is well-known in development economics that UDCs invariably start as debtor economies. In the process of development itself, t

Risk neutral persons, Risk Neutral - A person is a risk neutral if they...

Risk Neutral - A person is a risk neutral if they show no preference between certain, and an uncertain income with the same expected value.

Insurance, Sita expects her future earnings to be worth Rs 100. If she fall...

Sita expects her future earnings to be worth Rs 100. If she falls ill, her expected future earning will be Rs 25, There is a belief that she may fall ill 2 with probability of -3

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd