Question

In each of the cases below, identify whether the person is risk-neutral, risk-loving, or risk-averse:

- If Pete wins $10 from playing cards, his utility rises by 2100 units. If he loses $10 from playing cards, his utility decreases by 1900 units.

- Sarah’s utility function is U = 40 + 2Y (where Y is income).

- Xiodi has $50 and her utility is 7.07 units. If she has $60, her utility will be 7.75 units. If her income falls to $40, her utility will be 6.32 units.

Answer 1

Pete is risk loving because his utility function is convex (utility increases by a greater amount when income is increased by a given margin and utility decreases by a lesser amount when income is decreased by the same margin)

Sarah is risk neutral (impact on utility is the same as the utility function is linear with respect to income)

Xiodi is risk averse as utility function is concave (for the same variation in income, increase in utility = 7.75 - 7.07 = 0.68, decrease in utility = 7.07 - 6.32 = 0.75)