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In decision-making under uncertainty, explain why "expected utility" is preferred to "expected value" in consumer's optimization.
1. In decision-making under uncertainty, explain why "expected utility" is preferred to "expected value" in consumer's optimization. Describe a situation where maximizing "expected utility" and maximizing "expected value" are equivalent.
2. An individual has a utility function represented by U(I)= , where I is her annual income in dollars.
2.1 is the individual risk loving, risk neutral or risk averse?
2.2 Suppose this individual has a current disposable income of $90,000. Suppose that there is one percent (1%) chance that her house may burn down, and if it does, the cost of repairing it will be $80,000. thereby reducing her disposable income to %10,000. Calculate the expected value(income) and expected utility for this individual.
2.3 The individual is offered insurance to protect against the possibility of a fire. What would be a fair insurance premium? If the individual takes up the insurance, what is the maximum amount she should be willing to pay for this insurance?
