Problems 3
1.
Decision
Alternative
Investment A, d1
Investment B, d2
Investment C, d3
Probability
Up s1
100
75
50
0.40
Economics Conditions
Stable s2
Down s3
25
50
50
0.30
0
25
50
0.30
a. Using the expected value approach, which decision is preferred?
b. For the lottery having a payoff $100,000 with probability p and 50 with
probability (1-p), two decision maker expected the following indifference
probabilities Find the most preferred decision for each decision maker using the
expected utility approach
c. Why don’t decision maker A and B select the name the decision alternative?
Profit
$75,000
$50,000
$25,000
Indifference Probability (p)
Decision Maker A
0.80
0.60
0.30
Decision Maker B
0.60
0.30
0.15
2. In a certain state lottery, a lottery ticket cost $2. In term of decision to purchase or not
to purchase a lottery ticket, suppose that the following payoff table applies.
Decision Alternative
Purchase lottery ticket, d1
Do not purchase lottery ticket, d2
State of Nature
Win s1
300,000
0
Loss s1
-2
0
3. Suppose that the point spread for a particular sporting event is 10 point and that with
this spread you are convinced you would have a 0.60 probability of a bet on your
team. However, the local bookie will accept only a $1000 bet. Assuming that such bet
are legal, would you bet on team? (Disregard any commission charged by the bookie)
Remember that you must pay losses out of your own pocket. Your payoff table is as
follows
State of Nature
Decision Alternative
You Win
You Loss
Bet
1000
-1000
Don’t bet
0
0
a. What decision does the expected value approach recommend?
b. What is your indifference probability for the 50 payoff? (Although this choice
isn’t easy, be realistic as possible. It requires for an analysis that reflects your
attitude toward risk.)
c. What decision would you make based on the expected utility approach? In this
case are you a risk taker or risk avoider?
d. Would other individual assess the same utility value you do? Explain
e. If you decision in part (c) was to place the bet, repeat the analysis assuming a
minimum bet of $10,000