Suppose a farmer is debating whether to buy fertilizer to put on his land. The n

Question

Suppose a farmer is debating whether to buy fertilizer to put on his land. The net return to fertilizer will depend on whether there is a favorable rainfall. Suppose the payoff matrix is given by

Plan                 Rain                 No Rain

Fertilizer          75                       15

No Fertilizer    60                       30

(Probability)    (1/3)                   (2/3)

What would the farmer do if he were a risk seeker? Risk neutral? Risk averse? Explain. If your answer for any of the cases requires more information, indicate what you would need to know.

Explanation / Answer

Expected payoff in case of using fertilizer: (1/3)75 + (2/3)15 = 35

Expected payoff in case of not using fertilizer: (1/3)60 + (2/3)30 = 40

Clearly, the expected payoff from not using the fertilizer is greater than the expected payoff from using the fertilizer.

Risk seeker: Use Fertilizer

Risk neutral: Go for either of the two options

Risk averse: Not use the fertilizer

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