Asked by Brenda Degollado on May 27, 2024
Verified
Refer to Scenario 27-1. Suppose Lisa is faced with a choice between two options. With option A Lisa receives a guaranteed $9 million. With option B Lisa faces a lottery that pays $16 million with probability P and pays $4 million with probability (1-P). Given Lisa's utility function, how high does P need to be before Lisa will prefer option B?
Utility Function
Represents a mathematical model in economics which shows preferences over a set of goods and services, depicting satisfaction levels of consumers.
Probability
The measure of the likelihood that an event will occur, often expressed as a number between 0 and 1.
- Calculate the expected utility for different financial decisions under uncertainty and determine preferences based on utility maximization principles.
Verified Answer
KH
Kallie HoverMay 30, 2024
Final Answer :
Lisa will prefer option B if the expected utility from option B exceeds the utility from option A. This will occur when
4P = 2(1 - P) > 3
2P + 2 > 3
2P > 3
P > 1/2
4P = 2(1 - P) > 3
2P + 2 > 3
2P > 3
P > 1/2
Learning Objectives
- Calculate the expected utility for different financial decisions under uncertainty and determine preferences based on utility maximization principles.