1. Rosie has just written a book. Assume that her preferences are consistent with expected utility theory. There is 30% chance that her book will be a best-seller and make $500,000 in profit (after the costs of production) and a 70% chance it will just break even (i.e. no profit after the costs of production). Her current income is $150,000 (which she will receive regardless of what happens with her book) and her utility function is u (I) = ln (I) (a) Is Rosie risk-averse, risk-neutral, or risk-loving? How do you know? (b) Assume that Rosie will receive all of the profits (if any) from her book. Draw a diagram illustrating (i) Rosie's total income if her book just breaks even, (ii) her total income if her book is a best-seller, (iii) her expected income, (iv) her expected utility, (v) her certainty equivalent, and (vi) her risk premium. (c) Compute the numerical values associated with each of the six amounts you found in (b). (d) Acme Publishing Company has offered Rosie $100,000 for all the rights to her book. If Rosie agrees to the contract, she will get paid $100,000 today (for sure) and will not receive any more if the book turns out to be a success. Will Rosie take this contract?

1. Rosie has just written a book. Assume that her preferences are consistent with expected utility theory. There is 30% chance that her book will be a best-seller and make $500,000 in profit (after the costs of production) and a 70% chance it will just break even (i.e. no profit after the costs of production). Her current income is $150,000 (which she will receive regardless of what happens with her book) and her utility function is u (I) = ln (I) (a) Is Rosie risk-averse, risk-neutral, or risk-loving? How do you know? (b) Assume that Rosie will receive all of the profits (if any) from her book. Draw a diagram illustrating (i) Rosie's total income if her book just breaks even, (ii) her total income if her book is a best-seller, (iii) her expected income, (iv) her expected utility, (v) her certainty equivalent, and (vi) her risk premium. (c) Compute the numerical values associated with each of the six amounts you found in (b). (d) Acme Publishing Company has offered Rosie $100,000 for all the rights to her book. If Rosie agrees to the contract, she will get paid $100,000 today (for sure) and will not receive any more if the book turns out to be a success. Will Rosie take this contract?

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.5P

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