Alex, who is risk-neutral, is looking for an 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-neutral. If the cost to Alex of searching for another apartment is $30, then will he search for another apartment?

Question

Quizplus · Accepted Answer

The expected rent from searching is $680 (0.7*$700 + 0.2*$600 + 0.1*$500). Since $680 - $30 (search cost) = $650, which is less than $700, searching is a better-than-fair gamble.

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