Sep 28, 2017 term paper 2

CONSIDER A CONSUMER WITH UTILITY FUNCTION U = Y ½ . A. DEFINING THE COINCIDENT OF ABSOLUTE RISK…

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Consider a consumer with utility function U = Y½.

a. Defining the coincident of absolute risk aversion by

Show that this is a decreasing function of Y. The consumer is faced with a gamble that results in a loss of 1 with probability p = 0:5 and a gain of 2 with probability 1 – p.

b. Show that there is a critical value of income Y at which the consumer is indifferent between participating in this gamble and receiving income Y with certainty. Hence show that the gamble will be undertaken at any higher income but will not at any lower income.



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