Matt's Utility Function If Matt's current wealth is $51,000, then
A) his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is risk averse.
B) his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is not risk averse.
C) his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is risk averse.
D) his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is not risk averse.

Question

Matt's Utility Function  If Matt's current wealth is $51,000, then
A) his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is risk averse. 
B) his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is not risk averse. 
C) his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is risk averse. 
D) his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is not risk averse.

Quizplus · Accepted Answer

To determine if Matt is risk averse, we need to look at his utility function and the concept of diminishing marginal utility. According to his utility function, the coefficient of wealth is 0.8, which is less than 1. This means that Matt experiences diminishing marginal utility; that is, as his wealth increases, the additional utility he gains each time he receives an additional unit of wealth decreases.

Therefore, we can conclude that Matt is risk averse. If he gains $1,000, he will experience a gain in utility, but the marginal utility will be less than if he lost $1,000. The loss of $1,000 will result in a decrease in his utility, but the marginal utility will be higher. Therefore, the loss of $1,000 will have a greater impact on his utility than the gain of $1,000. This means that his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Hence, Option C is the correct answer.

Matt's Utility Function If Matt's Current Wealth Is $51,000