Risk aversion and indifference curve, Microeconomics

Risk Aversion and Income

- Variability in potential payoffs increases risk premium.

- Example:

  • A job has a .5% probability of paying $40,000 (utility of 20) and a 5 percent chance of paying 0 (utility of 0).

* The expected income is $20,000, but expected utility falls to 10.

Expected utility = .5u($) + .5u($40,000)

         = 0 + .5(20) = 10

* The certain income of $20,000 has a utility of 16.

*  If person is required to take the new position, the utility of them will fall by 6.

* The risk premium is $10,000 (that is they would be willing to give up $10,000 of the $20,000 and have same E(u) as the risky job.

*  Thus, it can be said that greater the variability, greater the risk premium.

*  Indifference Curve

- Combinations of the3 expected income & standard deviation of income which yield the same utility.

1808_risk aversion.png

2239_risk aversion1.png

Posted Date: 10/10/2012 8:52:05 AM | Location : United States







Related Discussions:- Risk aversion and indifference curve, Assignment Help, Ask Question on Risk aversion and indifference curve, Get Answer, Expert's Help, Risk aversion and indifference curve Discussions

Write discussion on Risk aversion and indifference curve
Your posts are moderated
Related Questions
A Period of Transition and Improvement: These few years stand out as the golden years for India's BOP. India had a small current account surplus (0.6 per cent of the GDP on an

Assignment: Externalities •Consider the following scenario: The city council has just approved the construction of a water park in your town. As city economist, you are responsible

Society of International Financial Telecommunications: The foreign exchange market operates worldwide, that is, the reach of the foreign exchange market is global. The foreign


1.  Moving from an economically inefficient to efficient allocation of resources will necessarily increase benefits by more than costs. 2.  There are two demand curves for a pri

Communications: Noting the importance of improved communications in increasing productivity and welfare, the New Telecom Policy (NTP) was introduced in 1999. NTP 99 was aimed

Explain about the perfect competition according to economics theory. The procedure of testing and refining theories is the key to the development of modern economics like a sci

Discuss the possible solutions for private solutions (Coase Theorem) Question 8: Demand: P=100-Q Supply: P=Q MEB= 10 Discuss the possibility of over or under allocations of reso

Malthus and the Food Crisis - Malthus predicted starvation as diminishing returns limited agricultural output and the population continued to grow. - Why did Malthus' predic

Supply of Basic Industrial Inputs: Allowing their duty-free imports by exporters would require an elaborate machinery of customs and import licensing to ensure that the impor