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

Market, describe engineering cost theory in detail

describe engineering cost theory in detail

Educational financing, Normal 0 false false false EN-IN...

Normal 0 false false false EN-IN X-NONE X-NONE MicrosoftInternetExplorer4

Explain labour intensity, Q. Explain Labour Intensity? Labour Intensity...

Q. Explain Labour Intensity? Labour Intensity: Ratio of labour effort expended, compared to total on-the-job compensated labour time. A higher ratio of labour intensity reflect

Determine the profit function and profit maximizing value, Yuen, a travelli...

Yuen, a travelling salesman for snake oil, can produce the stuff at a marginal cost of 1. There are 100 potential customers in Vernon, each of whom has the following demand functio

Arbitrage pricing theory, Arbitrage Pricing Theor y Arbitrage ...

Arbitrage Pricing Theor y Arbitrage defines the procedure of continuously buying a security for privacy, currency, or commodity on one market and selling it in another

Private benefit and social benefit, Private benefit and social benefit: ...

Private benefit and social benefit: Bridge the gab between private cost and social cost, and private benefit and social benefit.Under perfect market, there may be a divergence

Classical model , Money market, labour market, goods market

Money market, labour market, goods market

Computers , During the 1990s, technological advance reduced the cost of com...

During the 1990s, technological advance reduced the cost of computer chips. Explain, with the use of supply and demand diagrams, how the following markets are affected in terms of

Market supply of labour, Use a graphical illustration to describe briefly w...

Use a graphical illustration to describe briefly what the influence of each of the following would be on the market supply of labor:(a) an increase in immigration (b) more women en

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