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ECO 500 CHAPTER 12 HOMEWORK

ECO 500 CHAPTER 12 HOMEWORK

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Problem 12-01
Consider the two options in the following table, both of which have random outcomes:
Option 1

Option 2

Probability of Outcome

Possible
Outcomes ($)

Probability of Outcome

Possible
Outcomes ($)

1/16

150

1/5

120

4/16

300

1/5

255

6/16

750

1/5

1,500

4/16

300

1/5

255

1/16

150

1/5

120

a. Determine the expected value of each option.
b. Determine the variance and standard deviation of each option.
c. Which option is most risky?
 
Problem 12-02
For each of the following scenarios, determine whether the decision maker is risk neutral, risk averse, or risk loving.
Problem 12-03
Your store sells an item desired by a consumer. The consumer is using an optimal search strategy; the accompanying graph shows the consumer’s expected benefits and costs of searching for a lower price.
a.  What is the consumer’s reservation price?
b.  If your price is $3 and the consumer visits your store, will she purchase the item or continue to search?
c.  Suppose the consumer’s cost of each search rises to $16. What is the highest price you can charge and still sell the item to the consumer if she visits your store?
d.   Suppose the consumer’s cost of each search falls to $2. If the consumer finds a store charging $3, will she purchase at that price or continue to search?
Problem 12-14 (Algo)


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