Exam 12: Decision Making Under Uncertainty

A manager reveals that she has a utility function U = 100M - 2M², for 0 ≤ M ≤ 25, where 'U' stands for Utility, 'M' stands for Money. Is this person risk averse, risk neutral, or risk loving?

Consumer surveys indicate that 40% of newspaper readers read automobile ads and 5% of those who read the ads actually purchase automobiles. On the other hand, 50% of magazine readers read automobile ads but only 3% of those who read the ads actually buy a car. Among those who do not read either newspaper or magazine auto ads, 1% buys cars anyway. Sixty percent of the population reads newspapers, while 20 percent primarily read magazines. Compute the overall percentage of the population that purchases automobiles in a given year. (To aid your analysis, you might wish to draw a decision tree listing appropriate probabilities for the three aforementioned reading segments.)

A manager who sets U($20,0000) = 20, U($40,000) = 40, U($60,000) = 70 has a utility function that:

Decision trees are numerically evaluated:

Estimate the expected utility of two individuals, A and B, from the investment that has the following possible outcomes: PROBABILITY OUTCOME A's UTILITY B's UTILITY 0.3 \ 10,000 10 10 0.4 \ 30,000 30 20 0.3 \ 80,000 80 40

An individual is said to risk averse if his/her certainty equivalent for a risky prospect is:

A firm is thinking about introducing a new product. Marketing experts have determined that the product has a 10% chance of high success, a 60% chance of moderate success, and a 30% chance of failure. The gross profit from high success is $2.2 million and from moderate success $1.2 million. The estimated gross loss from failure is $500,000. Finally, the cost of introducing the product is $700,000. Should the firm introduce the product?

Risk aversion describes a person's tendency to:

A movie studio faces uncertainty about the cost of producing a film. Its cost can be $40 or $60 million with probabilities .6 and .4 respectively. The box office revenue from the film is also uncertain, either $60 million or $40 with probabilities .3 and .7 respectively. The film's expected profit is