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Terry is an attorney whose utility function is u(y,e)=ye, where y denotes his income and e his effort
devoted to work. He can exert two possible levels of effort: e1=1 and e2=4. There are two possible
levels of income: y1=100 and y2=400. The table below shows the probability of each income being
realized given his effort: a. If Terry works alone, which effort level will he choose? What will be his
expected utility? b. Suppose another attorney, Ron, joins Terry's firm, and the two now work as
partners. Ron is identical to Terry in every respect, and the income risks faced by them are
independent. They will each receive a half of the firm's total income. If Ron chooses high effort e2
, what will be Terry's expected utility if he also chooses e2 ? (Hint: first find Terry's income
prospect.) c. Now show that if Ron chooses e2, Terry's expected utility will actually be higher if he
himself chooses e1 instead of e22

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Terry is an attorney whose utility function is uyeypath.pdf

  • 1. Terry is an attorney whose utility function is u(y,e)=ye, where y denotes his income and e his effort devoted to work. He can exert two possible levels of effort: e1=1 and e2=4. There are two possible levels of income: y1=100 and y2=400. The table below shows the probability of each income being realized given his effort: a. If Terry works alone, which effort level will he choose? What will be his expected utility? b. Suppose another attorney, Ron, joins Terry's firm, and the two now work as partners. Ron is identical to Terry in every respect, and the income risks faced by them are independent. They will each receive a half of the firm's total income. If Ron chooses high effort e2 , what will be Terry's expected utility if he also chooses e2 ? (Hint: first find Terry's income prospect.) c. Now show that if Ron chooses e2, Terry's expected utility will actually be higher if he himself chooses e1 instead of e22