Exam 5: Uncertainty and Consumer Behavior

People often use probability statements to describe events that can only happen once. For example, a political consultant may offer their opinion about the probability that a particular candidate may win the next election. Probability statements like these are based on ________ probabilities.

An individual with a constant marginal utility of income will be

Figure 5.3 -The individual pictured in Figure 5.3

Irene's utility of income function is U(I) = 20I + 300. Irene is offered the following game of chance. The odds of winning are ¹/₁₀₀ and the pay-off is 75 times the wager. If she loses, she loses her wager amount. Calculate Irene's expected utility of the game.

Consider the following information about job opportunities for new college graduates in Megalopolis:Table 5.1 -Refer to Table 5.1. Ranked highest to lowest in expected income, the majors are

Figure 5.2 -When facing a 50% chance of receiving $50 and a 50% chance of receiving $100, the individual pictured in Figure 5.2

Consider the following information about job opportunities for new college graduates in Megalopolis:Table 5.1 -Refer to Table 5.1. A risk-averse student making a decision solely on the basis of the above information

Jonathan and Roberto enjoy playing poker. Jonathan's utility as a function of winning a poker hand is U_J = { . Roberto's utility as a function of winning a poker hand is U_R = { . Unfortunately for Jonathan, he has a habit of whistling only when he gets a full-house or better. Roberto, however, has not noticed this habit. Roberto currently has three-of-a-kind (which will lose to a full-house or better). Roberto believes that the probability Jonathan can beat his three-of-a-kind is ¹/₁₀. Roberto could choose to fold or play the hand. Calculate Roberto's expected utility according to his beliefs. Jonathan is currently whistling. How much could Roberto increase his utility by recognizing Jonathan's whistling habit?

Scenario 5.7: As president and CEO of MegaWorld industries, Natasha must decide on some very risky alternative investments. Consider the following: -Refer to Scenario 5.7. As a risk-neutral executive, Natasha

Figure 5.2 -The individual pictured in Figure 5.2

The indifference curve between expected return and the standard deviation of return for a risk-averse investor

The indifference curves of two investors are plotted against a single budget line. Indifference curve A is shown as tangent to the budget line at a point to the left of indifference curve B's tangency to the same line.

Farmer Brown grows wheat on his farm in Kansas, and the weather during the growing season makes this a risky venture. Over the many years that he has been in business, he has learned that rainfall patterns can be categorized as highly productive (HP) with a probability of .2, moderately productive (MP) with a probability of .6, and not productive at all (NP) with a probability of .2. With these various rainfall patterns, he has also learned that the inflation adjusted yields are $25,000 with NP weather, $10,000 with MP weather, and $50,000 with HP weather. Calculate the expected yield from growing wheat on Farmer Brown's farm. What can be learned about Brown's attitude toward risk from this problem? Explain.

Any risk-averse individual would always

Which of the following statements is true?

The relationship between income and total utility for three investors (A, B, and C) is shown in the tables below. A B C Income TU Income TU Income TU 5,000 14 5,000 4 5,000 6 10,000 24 10,000 8 10,000 14 15,000 32 15,000 12 15,000 24 20,000 38 20,000 16 20,000 36 25,000 43 25,000 20 25,000 52 30,000 47 30,000 24 30,000 72 35,000 49 35,000 28 35,000 100 Each investor has been confronted with the following three investment opportunities. The first opportunity is an investment which pays $15,000 risk free. Opportunity two offers a 0.4 probability of a $25,000 payment and a 0.6 probability of paying $10,000. The final investment will either pay $35,000 with a probability of 0.25 or $5,000 with a probability of 0.75. Determine the alternative each of the above investors would choose. Provide an intuitive explanation for the differences in their choices.

The tendency for individuals to assign higher values to goods when they own the goods than when they do not possess the goods is known as the:

Suppose you cannot buy information that completely removes the uncertainty from a business decision that you face, but you could buy information that reduces the degree of uncertainty. Based on the discussion in this chapter, the value of this partial information could be determined as the:

The object of diversification is

Sandra lives in the Pacific Northwest and enjoys walking to and from work during sunny days. Her utility is sharply diminished if she must walk while it is raining. Sandra's utility function is U = 1,000 I₁ + 250 I₂ + 1 I₃ where I₂ = 1 if she walks and there is no rain and I₁ = 0 otherwise, I₂ = 1 if she drives to work and I₂ = 0 otherwise, and I₃ = 1 if she walks and it rains and I₃ = 0 otherwise. Sandra believes that the probability of rain today is ³/₁₀. Given her beliefs, what is her expected utility from walking to work? What is her expected utility from driving to work according to her beliefs? If Sandra maximizes her expected utility according to her beliefs, will she drive or walk to work? Sandra missed the weather report this morning that stated the true probability of rain today is ⁴/₅. Given the weather report is accurate, what is Sandra's true expected utility from walking and driving to work? How much could Sandra increase her expected utility if she read and believed the weather report?