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
If a large amount of skilled labor immigrated into the country, which allows the available resources to produce more of goods X and Y, which of the following will occur? A.the y-i


Normal 0 false false false EN-IN X-NONE X-NONE MicrosoftInternetExplorer4

What is demographic transition In the world today not all nations have gone through their demographic transitions. Many countries today aren't rich enough to have begun populat

Briefly explain the main macroeconomic objectives of governments. Definition of macroeconomic issues Growth a)      Enhance in national income per unit of time, a

Define the production terminology in short. Production Technology: Production is the procedure of transforming inputs to outputs. Characteristically, inputs consist of labor

1. The two-way ANOVA, non-orthogonal case, has been a vexing problem for ANOVA researchers for many years.  Please answer the following questions concerning the two-way non-orthogo

Normal 0 false false false EN-IN X-NONE X-NONE MicrosoftInternetExplorer4 The demand schedule c

do you think that dimnishing returns to a factor are consistent with increasing returns to scale? explain with suitable diagram and reasoning.

I don''t understand PPC at all