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Utility Function: Ordering Prospects

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An individual has the following utility function: u(w)=w^5 where w=wealth.

a. Using expected utility, order the following prospects in terms of preference, from the most to the least preferred:
P1(.8, 1000, 600)
P2(.7, 1200, 600)
P3(.5, 2000,300)

b. What is the certainty equivalent for prospect P2?

c. Without doing any calculations, would the certainty equivalent for prospect P1 be larger or smaller? Why?

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Solution Summary

This solution shows how to use expected utility to order the given prospects in terms of preference, and evaluate the given prospects based on other criteria.

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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