ECO 3105: Group Assignment 4

November 24, 2023

1. Consider a decision maker who has the following preferences over the mone-
tary gambles p = 3000, q = [4000, 0.8; 0, 0.2], p′ = [3000, 0.25; 0, 0.75], q ′ =
[4000, 0.2; 0, 0.8]:1

• p ≻ q ≻ q ′ ≻ p′

Do these preferences satisfy the independence axiom of vNM expected utility

theory? Support your answers with precise arguments.

2. Re-visit the Allais preferences discussed in class.

1 89 1
(a) p = [100000] and q = [500000, 10
; 100000, 100
; 0, 100
]
11 89 1 9
(b) p′ = [100000, 100
; 0, 100
] and q ′ = [500000, 10
; 0, 10
]

The DM’s preferences are given by p ≻ q and q ′ ≻ p′ . Can these preferences be

accommodated by the RDU model? Support your answer with precise arguments.

3. Let X = {10, 20, 30} and ∆(X) be the set of simple lotteries over X. Consider a
decision maker who has complete and transitive preferences, < ⊆ ∆(X) × ∆(X),
over the set of simple lotteries, with the strict preference relation and indifference
relation denoted by ≻ and ∼, respectively. Suppose she expresses the following
preferences:

30 ≻ 20 ∼ [30, 2/3; 10, 1/3] ∼ [30, 1/2; 20, 3/10; 10, 1/5] ≻ 10

(a) Can the above preferences be accommodated by the vNM expected utility
model?
(b) Can the above preferences be accommodated by the RDU model?

Provide precise arguments in support of your answers.

1
Note that p is the gamble that gives 3000 for sure

1
4. Consider a RDU decision maker who is characterized by a probability weighting
√
function w(p) = p2 and utility function u(x) = 10 x.
For this decision maker, what is the certainty equivalent of the lottery

[80, 1/12; 60, 1/4; 40, 1/6; 20; 1/2]

Is the certainty equivalent less or more than the expected utility of the gamble?

5. Construct an example with a well laid out motivation where the reversal of chance
and choice nodes may result in a reversal of a decision maker’s preferences.
(Please do not use the voting example I mentioned in class)

6. The following questions consider bets on an urn that contains 100 balls, with
each marked with a number from 1 through 4. The exact proportion of these
balls is unknown, but it is known that there are exactly 50 balls marked 1 or 2
and exactly 50 marked 3 or 4. One ball is to be drawn from this urn at random.
Let Ei , i = 1, 2, 3, 4 denote the state that the drawn ball is marked i.
The four acts shown in Table 1 are offered to a decision maker (DM).

Table 1
50 balls 50 balls
E1 E2 E3 E4

f1 404 404 101 101

f2 404 101 404 101

f3 303 303 202 202

f4 303 202 303 202

The DM is observed to have the following preferences over these acts:

f1 ≻ f2 and ≻ f4 ≻ f3
Can these preferences be accommodated by the subjective expected utility model?
Provide succinct arguments in support of your answer. In particular, show that
you can answer this question both from the point of view of the SEU represen-
tation and axioms underlying the representation.