Joanna is playing blackjack for real money. She has reference-dependent preferences over money: if her earnings are m and her reference point is r, then her utility is v(m − r), where the value function v satisfies v(x) = √x for x ≥ 0, and v(x) = −2√−x for x ≤ 0 a) Graph Joanna’s utility function as a function of m − r b) Does Joanna’s utility function satisfy loss aversion? Does it satisfy diminishing sensitivity? Suppose that Joanna has linear probability weights (that is, she does NOT have prospect theory’s non-linear probability weighting function). Hence, if she has a fifty-fifty chance of getting amounts m and m′, and her reference point is r, her expected utility is 1/2v(m − r) + 1/2v(m′− r) (2) For parts (c), (d), and (e), assume that Joanna’s reference point is $0 (that is, no wins or losses) and answer the following questions for each part: (i) What is the g for which Joanna would be indifferent between not gambling and taking fifty-fifty win $g or lose $4 gamble? (ii) Does this reflect risk-loving or risk-averse behavior? (iii) What features of Joanna’s reference-dependent preferences are driving this choice. c) This is the first round and Joanna has not won or lost any money yet. d)Joanna is $9 down. e) Joanna is $9 ahead. f) Referring to parts c, d, and e, when is Joanna most risk-averse? Explain the

ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
icon
Related questions
Question

Joanna is playing blackjack for real money. She has reference-dependent preferences over
money: if her earnings are m and her reference point is r, then her utility is v(m − r), where
the value function v satisfies v(x) = √x for x ≥ 0, and v(x) = −2√−x for x ≤ 0
a) Graph Joanna’s utility function as a function of m − r
b) Does Joanna’s utility function satisfy loss aversion? Does it satisfy diminishing
sensitivity?
Suppose that Joanna has linear probability weights (that is, she does NOT have prospect
theory’s non-linear probability weighting function). Hence, if she has a fifty-fifty chance of
getting amounts m and m′, and her reference point is r, her expected utility is
1/2v(m − r) + 1/2v(m′− r) (2)
For parts (c), (d), and (e), assume that Joanna’s reference point is $0 (that is, no wins
or losses) and answer the following questions for each part: (i) What is the g for which
Joanna would be indifferent between not gambling and taking fifty-fifty win $g or lose
$4 gamble? (ii) Does this reflect risk-loving or risk-averse behavior? (iii) What features of
Joanna’s reference-dependent preferences are driving this choice.
c) This is the first round and Joanna has not won or lost any money yet.
d)Joanna is $9 down.
e) Joanna is $9 ahead.
f) Referring to parts c, d, and e, when is Joanna most risk-averse? Explain the
intuition. 

Joanna is playing blackjack for real money. She has reference-dependent preferences over
money: if her earnings are m and her reference point is r, then her utility is v(mr), where
the value function v satisfies v(x)=√x for x ≥ 0, and v(x) = -2√x for x ≤ 0
Transcribed Image Text:Joanna is playing blackjack for real money. She has reference-dependent preferences over money: if her earnings are m and her reference point is r, then her utility is v(mr), where the value function v satisfies v(x)=√x for x ≥ 0, and v(x) = -2√x for x ≤ 0
1 v(m-r) +v(m²-r)
(2)
Transcribed Image Text:1 v(m-r) +v(m²-r) (2)
Expert Solution
steps

Step by step

Solved in 4 steps with 1 images

Blurred answer
Knowledge Booster
Taxes And Equity
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
Economics
ISBN:
9780190931919
Author:
NEWNAN
Publisher:
Oxford University Press
Principles of Economics (12th Edition)
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (MindTap Course List)
Principles of Economics (MindTap Course List)
Economics
ISBN:
9781305585126
Author:
N. Gregory Mankiw
Publisher:
Cengage Learning
Managerial Economics: A Problem Solving Approach
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Managerial Economics & Business Strategy (Mcgraw-…
Managerial Economics & Business Strategy (Mcgraw-…
Economics
ISBN:
9781259290619
Author:
Michael Baye, Jeff Prince
Publisher:
McGraw-Hill Education