Question

Your friend wants to participate in a lottery that pays $100 with a probability 1/100 and nothing otherwise. For simplicity, assume that participation is free.

1. Plot his Bernoulli utility function that is given by U(C) = C
^{2}. Is he risk-averse, risk-neutral or risk-loving?

2. Compute the expected value of the lottery and the expected utility from the lottery.

3. Show on a graph the expected value of the lottery and the expected utility from the lottery.

4. You are strongly against gambling. What minimal amount should you offer your friend to incentivize him not to play?

5. What if his Bernoulli utility function was given by U(C) = √ C? What minimal amount would be in that case?

Answer #1

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investment. Further assume that his utility function is given by
u(w) = -w2 + 100w.
Answer each of the following.
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