Microeconomics 2nd Edition by Douglas Bernheim

Exercise 4

Lucy lives in a bad neighborhood, and will be robbed with a 25 percent probability. She cares only about lemonade, but the amount of lemonade she drinks may depend on whether she is robbed. We will use L R to stand for the amount of lemonade she drinks if she is robbed, and L N to stand for the amount she drinks if she is not robbed. Suppose we can represent Lucy's preferences with an expected utility function, and that W ( L ) = 1/ L. Plot the indifference curve that runs through the point ( L R , L N )= (500, 500). Plot the constant expected consumption line that runs through this same point. Is Lucy risk averse, risk loving, or risk neutral Is Lucy's benefit function concave or convex Graph it.