Numerical Examples

• Two identical boxes are there

• One box contains 4 chocolates and another 38
chocolates.
• You have to choose any one

Or
You can choose a 3rd box which contains………
amount of chocolate.
• What should be the minimum number of
chocolates in the 3rd box??
• A Person has an expected utility function of
the form u(w)=√w.
• He initially has wealth of Rs 4.he has a lottery
ticket that will worth Rs 12 with probability ½
and will worth 0 with probability ½.
• what is the expected utility? What is the
lowest price P at which he would part with the
ticket?
• U(w)=√w
• EU=1/2 (√4+√(12+4))
• =1/2 (4+2)=3
• If he sells the ticket price p, he needs to get at least utility 3.
• 3=√4+p
• 9-4=p
• P=5

• Expected Value of Lottery:1/2 *16+1/2*4=10

• CE=9
• EV>CE as he is risk averse
• Lib’s utility function is given by U(I)={100-(100,000/I)}
• She is currently earning an income of Rs 20,000 and can earn that
income next year also.
• She is offered a new job that offers 50% chance of earning 25,000
and 50% chance of earning 15,000.
• Will she accept the job?
• If Lib is willing to purchase an insurance against the variable
income what would be the maximum amount she would pay for
insurance?
• U(20,000)=100-{100,000/20,000}
• =95
• U (25,000)=100-{100,000/25,000}
• =96
• U(15,000)=100-{100,000/15,000}
• =93.34
• EU=1/2(96+93.34)=94.67
• 94.67=100-(100,000/I)
• I= 18,726.6;CE=18,726.6
• Expected value=1/2(15,000+25,000)=20,000
• RP=EV-CE
• =
 The Markowitz Premium
U(W)

U (w2)

U (EV)

EU

u(w1)

0 CE W
w1 ev w2 8