Suppose Mabel has a utility function U = I1/2.
What is Mabel’s general attitude toward risk? How do you know? Explain.
Suppose Mabel currently has I = $100. She is considering an investment that has a 50% probability of raising her income to $120 and a 50% probability of reducing it to $80. What is the expected value of the investment?
Will Mabel invest? Explain.
What certain amount of money represents the same utility as the investment to Mabel?
What is Mabel’s risk premium in this situation, that is, up to how much would she actually pay to avoid the investment?