Oliver takes his wealth of $1,000 to a casino. He can bet as much as he likes on the toss of a coin but the "house" takes a cut. If Oliver bets $x on heads, then if heads comes up, he gets $.8x and, if tails comes up, he pays $x. Similarly if he bets $x on tails and if tails comes up, he wins $.8x and, if heads comes up, he pays $x. Draw a graph with dollars contingent on heads and dollars contingent on tails on the two axes. Show Oliver's budget constraint. Oliver is an expected utility maximizer with the utility function , where h is his wealth if heads comes up and t is his wealth if tails comes up. Draw the highest indifference curve that Oliver can reach with his budget. What bets if any does he make?

Question

Oliver takes his wealth of $1,000 to a casino. He can bet as much as he likes on the toss of a coin but the "house" takes a cut. If Oliver bets $x on heads, then if heads comes up, he gets $.8x and, if tails comes up, he pays $x. Similarly if he bets $x on tails and if tails comes up, he wins $.8x and, if heads comes up, he pays $x. Draw a graph with dollars contingent on heads and dollars contingent on tails on the two axes. Show Oliver's budget constraint. Oliver is an expected utility maximizer with the utility function  , where h is his wealth if heads comes up and t is his wealth if tails comes up. Draw the highest indifference curve that Oliver can reach with his budget. What bets if any does he make?

Quizplus · Accepted Answer

The Answer of Oliver takes his wealth of $1,000 to a casino. He can bet as much as he likes on the toss of a coin but the "house" takes a cut. If Oliver bets $x on heads, then if heads comes up, he gets $.8x and, if tails comes up, he pays $x. Similarly if he bets $x on tails and if tails comes up, he wins $.8x and, if heads comes up, he pays $x. Draw a graph with dollars contingent on heads and dollars contingent on tails on the two axes. Show Oliver's budget constraint. Oliver is an expected utility maximizer with the utility function  , where h is his wealth if heads comes up and t is his wealth if tails comes up. Draw the highest indifference curve that Oliver can reach with his budget. What bets if any does he make?

Oliver Takes His Wealth of $1,000 to a Casino