Suppose you must choose between the two prospects, (40,000, 0.025) or (1,000): The prospect of winning 40,000 with a probability of 2.5% or winning 1,000 with certainty. Suppose, too, that the following three graphs represent your utility function (according to expected utility theory) and your weighting and value scales (according to prospect theory). Finally, suppose that your current wealth is 20,000. a. What is the expected utility for the two prospects? b. Based on expected utility theory, which prospect would you choose? Why? c. According to prospect theory, what are the values for each of the prospects? d. Based on prospect theory, which prospect would you choose? Why? e. Why is your decision different under the two theories? (Hint: what is one of the common human traits that prospect theory captures that expected utility theory cannot?)
Suppose you must choose between the two prospects, (40,000, 0.025) or (1,000): The prospect of winning 40,000 with a probability of 2.5% or winning 1,000 with certainty. Suppose, too, that the following three graphs represent your utility function (according to expected utility theory) and your weighting and value scales (according to prospect theory). Finally, suppose that your current wealth is 20,000.
a. What is the expected utility for the two prospects?
b. Based on expected utility theory, which prospect would you choose? Why?
c. According to prospect theory, what are the values for each of the prospects?
d. Based on prospect theory, which prospect would you choose? Why?
e. Why is your decision different under the two theories? (Hint: what is one of the common human traits that prospect theory captures that expected utility theory cannot?)
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