Expected Utility

| April 22, 2014

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Mark M. Upp has just been fired as the university bookstore manager for setting prices too low (only 20 percent above suggested retail). He is considering opening a competing bookstore near the campus. There are two possible sites under consideration. If he opens the Small site and demand is good, he will generate a profit of $50,000. If demand is bad, he will lose $5,000. If he opens the Large site and demand is good he will generate a profit of $70,000, but he will lose $40,000 if demand is bad. He also has the option of not opening either. He believes that there is a 60 percent chance that demand will be good. He assigns the following utilities to the different profits:
U(0) = 0.12
U(50,000) = 0.5 U(-5,000) = 0.1
U(70,000) = 1 U(-40,000) = 0
What is the Expected Utility of each of Mark’s decision alternatives?
Based on Expected Utility, which decision should Mark make?
Is Mark a risk taker, risk avoider or risk neutral?
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