Chapter 5

Question 1

what is the expected utility of an uncertain outcome?

Answer 1

the sum of utilities associated with all possible outcomes, weighted by the probability that each outcome will occur

Question 2

what is expected value?

Answer 2

Probability-weighted average of the payoffs associated with all possible outcomes

Question 3

what is a payoff?

Answer 3

Value associated with a possible outcome

Question 4

what is variability?

Answer 4

Extent to which possible outcomes of an uncertain event differ

Question 5

what is meant by the term ‘risk adverse’?

Answer 5

Condition of preferring a certain income to a risky income with the same expected value

Question 6

what is meant by the term ‘risk loving’?

Answer 6

Condition of preferring a risky income to a certain income with the same expected value

Question 7

what is meant by the term ‘risk neutral’?

Answer 7

Condition of being indifferent between a risky income and a certain income with the same expected value.

Question 8

what is expected utility?

Answer 8

Sum of the utilities associated with all
possible outcomes, weighted by the probability that each outcome will occur

Question 9

what is risk premium?

Answer 9

Maximum amount of money that
a risk-averse person will pay to avoid taking a risk