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14 June, 06:28

A girl is given $15 by her parents. She has two options of how to spend the money. She can either save the money for future purchases or she can start a lemonade stand on her driveway. If she spends her $15 on the lemonade stand, there is a 50% probability she will lose $10 and a 50% probability she will make $12. Assuming the girl has a square root utility function, what should the girl do with the money?

a. Start her lemonade stand.

b. Save her money.

c. The outcome is the same for both choices.

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  1. 14 June, 08:09
    0
    B) Save her money.

    Explanation:

    The girl's utility of saving her money = √$15 = $3.87

    If the girl starts her lemonade business, the expected utility of her investment = (50% x √$5) + (50% x √$27) = (50% x $2.236) + (50% x $5.196) = $1.118 + $2.598 = 3.72

    Since the utility of saving her money ($3.87) is > than the utility obtained by the investment ($3.72), the girl should save her money.
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