The utility from wealth is . An individual owns a risky asset that is equally likely to yield Rs. 400 or Rs. 900. The risk premium of the asset (in Rs.) is
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2 marks, −0.667MicroeconomicsChoice under uncertaintyRisk aversion, certainty equivalent and risk premiumModerateabout 2 min
IIT JAM 2021 Question 13: Choice under uncertainty
Answer and worked solution
Answer: (B)
Expected wealth is . Expected utility is .
The certainty equivalent solves , so . The risk premium is expected wealth minus the certainty equivalent, . The answer is (B).
The trap: (C) 625
The certainty equivalent 625 is not the risk premium; the premium is the gap between expected wealth (650) and the certainty equivalent, which is 25.
Plain-text version
The utility from wealth is u(w) = √w. An individual owns a risky asset that is equally likely to yield Rs. 400 or Rs. 900. The risk premium of the asset (in Rs.) is (A) 5 (B) 25 (C) 625 (D) 650
Also written as: The utility from wealth is u(w) = sqrt(w). An individual owns a risky asset that is equally likely to yield Rs. 400 or Rs. 900. The risk premium of the asset (in Rs.) is
Choice under uncertainty has come up 27 times in 7 exams since 2007.
What this question tests
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 IIT JAM 2021 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.