Which of the following best describes why individuals are risk-averse?
A. individuals enjoy volatility. B. individuals experience diminishing marginal utility of wealth. C. individuals wish to maximize total consumption at all costs. D. none of these. Individuals are generally not risk-averse.
The correct answer is (B) individuals experience diminishing marginal utility of wealth
Individuals are risk averse when Expected utility of wealth is lesser than utility of Expected wealth i.e. u(E(W) >E(u(W))
We can also say this as individuals are risk averse when utility of wealth function is concave i.e. u''(W) < 0
this means that in order for individual to be a risk averse u'(W) should be decreasing
As Marginal utility of wealth = u'(W)
Hence, Individuals are risk averse because of diminishing marginal utility of wealth.
Hence, the correct answer is (B) individuals experience diminishing marginal utility of wealth
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