In the class lecture notes, we motivated how “risk aversion” (the dislike of risk) is the same as diminishing marginal utility of wealth. The basic idea is thatSelected answer will be automatically saved. For keyboard navigation, press up/down arrow keys to select an answer.aFrom a utility standpoint, the pain of losing $100 is greater than the happiness of winning $100.bThe greater a person’s wealth, the more the person dislikes taking a gamble.cAn insurance company typically charges a higher premium to wealthier customers.dWealthier people are in a better position to take gambles because they will still have money left over.
Question
In the class lecture notes, we motivated how “risk aversion” (the dislike of risk) is the same as diminishing marginal utility of wealth. The basic idea is thatSelected answer will be automatically saved. For keyboard navigation, press up/down arrow keys to select an answer.aFrom a utility standpoint, the pain of losing 100.bThe greater a person’s wealth, the more the person dislikes taking a gamble.cAn insurance company typically charges a higher premium to wealthier customers.dWealthier people are in a better position to take gambles because they will still have money left over.
Solution
The correct answer is a) From a utility standpoint, the pain of losing 100.
This is based on the concept of diminishing marginal utility of wealth, which states that as a person becomes wealthier, each additional unit of wealth brings less and less additional happiness or utility.
Here's a step-by-step explanation:
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Let's say you have 100, you now have 100 is a certain amount.
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Now, let's say you have 100, you now have 100 doesn't make you as happy as the first 1000. This is diminishing marginal utility.
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Now, let's consider losing 1000 and lose 900. This loss makes you quite unhappy.
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But if you have 100, you're left with $1900. This loss makes you unhappy, but not as much as when you had less money.
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However, the unhappiness from losing 100, no matter how much money you have. This is because of risk aversion - people prefer to avoid losses rather than acquire equivalent gains.
So, the concept of risk aversion is closely tied to the concept of diminishing marginal utility of wealth.
Similar Questions
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