Sudhir's total wealth next year, including his house, will be Rs. 5,00,000. There is a 10 percent chance a big earthquake occurs next year and completely destroys his house, valued at Rs. 2,00,000. (i) What is Sudhir's expected wealth next year if he does not buy house insurance? (ii) If his utility is (W in thousands of rupees), is Sudhir risk-averse, risk-loving, or risk-neutral?
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Sudhir's total wealth next year, including his house, will be Rs. 5,00,000. There is a 10 percent chance a big earthquake occurs next year and completely destroys his house, valued at Rs. 2,00,000. (i) What is Sudhir's expected wealth next year if he does not buy house insurance? (ii) If his utility is U(W)=W⁰·⁵ (W in thousands of rupees), is Sudhir risk-averse, risk-loving, or risk-neutral? (A) (i) Rs. 4,50,000 and (ii) risk-averse (B) (i) Rs. 4,50,000 and (ii) risk-neutral (C) (i) Rs. 4,80,000 and (ii) risk-loving (D) (i) Rs. 4,80,000 and (ii) risk-averse
Also written as: Sudhir's total wealth next year, including his house, will be Rs. 5,00,000. There is a 10 percent chance a big earthquake occurs next year and completely destroys his house, valued at Rs. 2,00,000. (i) What is Sudhir's expected wealth next year if he does not buy house insurance? (ii) If his utility is U(W)=W^(0.5) (W in thousands of rupees), is Sudhir risk-averse, risk-loving, or risk-neutral?
Choice under uncertainty has come up 27 times in 7 exams since 2007.
This question is on Risk aversion, certainty equivalent and risk premium, part of Choice under uncertainty in Microeconomics.
How the shape of utility reveals attitude to risk and how much a person would pay to avoid it.
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Question from the DSE 2007 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.