Question

Consider the following scenarios.

a. Scenario one has two options available.

• Option A: There is a 50% chance of winning $1,000 and a 50% chance of winning $0.
• Option B: There is a 100% chance of receiving $500.

A risk-averse person   (Click to select)   will choose option A   will choose option B   will be indifferent between options A and B   might choose option A or might choose option B  .

b. Scenario two has two different options available.

• Option C: There is a 40% chance of winning $90 and a 60% chance of winning $110.
• Option D: There is a 100% chance of winning $90.

A risk-averse person   (Click to select)   will choose option C   will choose option D   will be indifferent between options C and D   might choose option C or might choose option D  .

c. Scenario three has two more options available.

• Option E: There is a 50% chance of winning $0 and a 50% chance of winning $100.
• Option F: There is a 50% chance of winning $20 and a 50% chance of winning $60.

A risk-averse person   (Click to select)   will choose option E   will choose option F   will be indifferent between options E and F   might choose option E or might choose option F  .

Answer 1

a. A risk-averse person will choose option B. A risk averse person would not be willing to take the risk that the lottery comes with.

b. A risk-averse person will choose option C. The expected value of option C is greater than D, and the minimum payoff (=90) is same in both. Hence, the person is assured $90 in both cases and has a chance of greater than $90 is option C, hence the persone will choose C.

c. A risk-averse person will choose option F. The expected value of E is $50, and of F is $40. The minimum payoff of E is $0 whereas that of F is $20. A person who risk averse enough would prefer an assured payoff of $20, instead of a chance of $0.