SOLUTION

Chapter 8 discusses the issue of decision-making under uncertainty for firms, but the same principles can also be applied to individuals. Suppose there is a lottery that has the following possibilities: – 30% chance of winning 10$ – 35% of winning 20$ – 10% chance of winning 100$ – 25% chance of winning nothing. a) Calculate the expected gain from this lottery. b) If I gave you a choice between that lottery and flipping a coin with the following payoff; Head you make 40$ and tails you make nothing, which one would you take? Why?

Solution:

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