Expected Utility and Risk Aversion Lottery Problem with Certain Payoff Comparison and Worked Economic Decision Analysis — Let return the Texaco-Pennzoil example from Chapter think

Let us return to the Texaco-Pennzoil example from Chapter 4 and think about Liedtke’s risk attitude. Suppose that Liedtke’s utility function is given by the utility function in Table 14.5.

a. Graph this utility function. Based on this graph, how would you classify Liedtke’s attitude toward risk?

b. Use the utility function in conjunction with the decision tree sketched in Figure 4.2 to solve Liedtke’s problem. With these utilities, what strategy should he pursue? Should he still counteroffer $5 billion? What if Texaco counteroffers $3 billion? Is your answer consistent with your response to part a?

c. Based on this utility function, what is the least amount (approximately) that Liedtke should agree to in a settlement? What does this suggest regarding plausible counteroffers that Liedtke might make?

Table 14.5