PAI 789 Advanced Policy Analysis

Risk Averse Manager (p15)

The manager of a small nonprofit is two actions for helping the organization's target population. Action C is a conventional approach and action N is a newer option that's riskier. Both policies cost $100,000 and have either high (H) or low (L) gross payoffs. However, the payoffs and probabilities differ:

 Action StateProbability
Gross Payoff
C  H 75% $220,000
L 25% $180,000
N H 40% $700,000
L 60% $100,000

The manager maximizes expected utility (EU) when choosing policies, and their utility from a net payoff of `x` dollars is `u(x)=x^0.5` (that is, the square root of `x`).

1. Please determine the expected utility of each option and indicate which the manager would choose.

2. If you have time, also compute the expected value (EV) of each option and indicate what a risk neutral manager would choose.

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Peter J Wilcoxen, The Maxwell School, Syracuse University
Revised 04/06/2022