Alex, who is risk-neutral, is looking for a one-bedroom apartment to rent for the month of August while he's on vacation in Seattle. All of the one-bedroom apartments in the neighborhood where he wants to stay are of equal quality, but 70 percent rent for $700 per month, 20 percent rent for $600 per month, and 10 percent rent for $500 per month. The first apartment Alex finds rents for $700 per month. Suppose Alex is risk-averse. If the cost to Alex of searching for another apartment is $40, then will he search for another apartment?
A)No, because searching for another apartment is a less-than-fair gamble.
B)Yes, because searching for another apartment is a better-than-fair gamble.
C)No, because searching for another apartment is a fair gamble.
D)Yes, because searching for another apartment is a fair gamble.

Question

Quizplus · Accepted Answer

With probability 0.70, Alex will find another apartment that's the same price, with probability 0.20, Alex will find an apartment that's $100 cheaper, and with probability 0.10, Alex will find an apartment that's $200 cheaper. Thus, the expected value of searching for another apartment is $0 = (0.70)($0)+ (0.20)($100)+ (0.10)($200)- $40. If Alex is risk-averse, then he will refuse any fair gamble.

Alex, Who Is Risk-Neutral, Is Looking for a One-Bedroom Apartment