Question 5: Suppose that Jennifer evaluates gambles according to prospect theory

Question

Question 5: Suppose that Jennifer evaluates gambles according to prospect theory with (p-p and a value function that has the three properties suggested by Kahneman & Tversky. (a) If Jennifer chooses lottery ($800,.9:S0,1) over lottery ($1400,.5;S0,.5), could she also choose lottery ($1400,.25:S0,.75) over lottery ($800, .45;$0, 55)? Could prospect theory with r(p) p explain this pattern of choices? If so, how? If not, why not? 75) over lottery ($800, 45.50, (b) If Jennifer faces a 2% chance of incurring a loss of $20,000, would she be willing to purchase full insurance at a premium of $400? Does prospect theory with (p) p make a prediction for how a person should behave? If so, what is it? If not, why not? (c) If Jennifer faces a 60% chance of incurring a loss of $2000, would she be willing to purchase full insurance at a premi um of Si 200? Does prospect theory with (p)p make a prediction for how a person should behave? If so, what is it? If not, why not?

Explanation / Answer

Marginal analysis involves a cost-versus-benefits comparison of various business activities. In marginal analysis, the cost of an activity is measured against incremental changes in volume to determine how the overall change in cost will affect the bottom line of a business. Marginal analysis can show the cost of additional production by a business all the way up to the break-even point. This is generally the maximum cost that a business can sustain without losing money.

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