Q3.

a. The expected value of the lottery is equal to the sum of the returns weighted by their
probabilities:
EV = (0.5) (0) + (0.25) ($1.00) + (0.2) ($2.00) + (0.05) ($7.50) = $1.025
The variance is the sum of the squared deviations from the mean, $1.025, weighted by their
probabilities:
Variance = (0.5) (0 - 1.025)2 + (0.25) (1 - 1.025) 2 +(0.2) (2 - 1.025) 2 + (0.05) (7.5 -1.025) 2
= 2.812
b. As Richard is extremely risk-averse person, so utility function will be U(x) = √x
Utility for ticket = (0.5) (√9) +(0.25) (√10) + (0.2) (√11) + (0.05) (√16.5) = 3.157
Utility if he doesn’t buy = √10 = 3.162
As utility is less, He won’t buy the tickets.
c. Utility of the ticket = (0.5) (√0) +(0.25) (√1000) + (0.2) (√1100) + (0.05) (√1650) = 16.57
√CE = 16.57 => CE = 274.56
So, Richard can sell the tickets at $274.56.
d. Expected return on ticket = 0.25*1 + 0.20*2 + 0.05*7.50 = $1.025
So, state loses $0.025 on each ticket. The state must raise the price of a ticket, reduce some
of the payoffs, raise the probability of winning nothing, lower the probabilities of the positive
payoffs, or some combination of the above.