Chez Paul: Introduction The next few questions refer to this information: Chez P

Question

Chez Paul: Introduction The next few questions refer to this information: Chez Paul is contemplating either opening another restaurant or expanding its existing location. The payoff table for these two decisions is: States of Nature s1 S2 s3 New Restaurant -$80,000 $20,000 $160,000 Expand Paul has calculated the indifference probability for the lottery having a payoff of $160,000 with probability p and-$80,000 with probability (1-p) with the following sure amounts as follows: Amount Indifference Probability (p) $40,000 $20,000 $100,000 $40,000 $20,000 100,000 0.4 0.7 0.9 Question 17 5 pts Chez Paul: Part 1 Is Paul a risk avoider, a risk taker, or risk neutral? Why?

Explanation / Answer

Part 1

* 160000 x 0.4 + (-80000) x 0.6 = 16,000

Part 2

* 80 x 0.4 + 0 x 0.6 = 32

Part 3

Select - Expand  

Expected value calculations

Select - New Restaurant.

So, the expected value approach and the utility approach gives us opposite decisions.

Sure Amounts p (1-p) Best x p + Worst x (1-p) Position ($40,000) 0.4 0.6 $16,000 * Risk avoiding $20,000 0.7 0.3 $88,000 Risk avoiding $100,000 0.9 0.1 $136,000 Risk avoiding

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