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Question:
(a) Describe the axioms of utility.
(b) An economic agent has a logarithmic utility function, U(W) = lnw and has initial wealth $20,000. She is offered the subsequent gamble at a participation cost of $700. She will win $5000 with probability 0.2; win $2000 with probability 0.4 or lose $1500.
REQUIRED
i. What is the expected utility of wealth from taking the gamble? ii. What is the Certainty Equivalent Wealth?iii. What is the utility from Expected Wealth? iv. If she offered insurance for $200, will she take it? v. In case she lost on the first round, what is her expected utility of wealth from taking the gamble a second time?
(c) Explain the Savage Friedman Hypothesis.
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