Suppose that a person won the Florida lottery and was offered a choice of two prizes

Question:

Suppose that a person won the Florida lottery and was offered a choice of two prizes: (1) $500,000 or (2) a coin-toss gamble in which he or she would get $1 million if a head were flipped and zero if a tail.

a. What is the expected dollar return on the gamble?

b. Would the person choose the sure $500,000 or the gamble?

c. If he or she chooses the sure $500,000, is the person a risk averter or a risk seeker?

Answer:

a. expected dollar return on the gamble = 0.5* $1 million + 0.5*0 = $500,000
Since probability of both head and tail is 0.5

b. The person would choose sure $500,000 or the gamble depending upon the risk taking abilities of the person. If he or she chooses gamble, the person is risk seeker.

c. If he or she chooses the sure $500,000, the person is risk averse.

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