Efren Chan

BSBA 3B

• Differentiate the following terms/concepts:

a. The utility function and expected utility.

b. Risk aversion, risk-seeking, and risk neutrality.

Answer:
a. Utility function is the calculation for how much someone desires
something, it is a representation to define individual preference for goods
and services whereas Expected utility is the comparison of certain products
or services and its alternatives in the market.
b. Risk aversion is trying to choose a guaranteed payment or lower the
possible risk may occur that a person is currently experiencing. Risk seeking
refers to an individual who is willing to accept greater economic uncertainty
in exchange for the potential of higher returns. While Risk neutrality used to
describe the attitude of an individual who may be evaluating investment
alternatives.

2. Pedro has a keen love for fast food, He prefers spaghetti over a
hamburger. Last night, she had a choice of spaghetti or macaroni and
cheese and decided on the spaghetti again. The night before, Pedro had a
choice of spaghetti, pizza, or a hamburger, and this time she had pizza.
Then, today, he chose macaroni and cheese over a hamburger. Does his
selection today indicate that Pedro’s choices are consistent with economic
rationality? Why or why not?

Answer:
It is consistent based on economic rationality, it seems like he prefers
pastas more than burger and it shows above that he chooses pasta over
burgers almost everytime he orders in fast food.

• Answer the following problems and explain your

answer. Problem 1: Choose between
Prospect A and Prospect B.
Prospect A: ₱2,500 with probability .33

₱2,400 with
probability .66 Zero
with probability .01
 Prospect B: ₱2,400 with certainty.

Answer: I will choose prospect A, because it is you

have a high chance to come up with 2,500 and 2,400
that almost a 100%.

Problem 2: Choose between Prospect C and Prospect D.

Prospect C: ₱2,500 with probability .33

Zero with probability .67

Prospect D: ₱2,400 with probability .34

Answer:
I'll go with prospect D, porspect c probability of getting
zero is way to high. In the other hand if ever you dont
land the .34, you still will not get P0.

Answer:

Allais paradox is in direct contradiction with expted utility theory, becuase in Allais
paradox you choose your choice with probabilities, you calculate the possible outcomes
and lower the loss and increase your gains. Whereas expected utility theory has nothing
to do with probability and just go for the highest expected utility withouth knowing other
outcomes, I would say that expected utility theory is for those high risk taker as it is not
giving a proper analyzation of the chosen decision. Wherein Allais paradox helps you
analyze and make you choose a steady decision in evaluating oppurtunities in the right
way.