SOLUTION: It's a Microeconomic question related to choice under uncertainty:
Kate will earn $150,000 this year for certain. However, Sam’s income depends on whether he is able to earn
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Kate will earn $150,000 this year for certain. However, Sam’s income depends on whether he is able to earn
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Question 1151611: It's a Microeconomic question related to choice under uncertainty:
Kate will earn $150,000 this year for certain. However, Sam’s income depends on whether he is able to earn a large bonus - his income is will be $80,000 without the bonus but $200,000 if he gets the bonus. The probability that he receives the bonus is 0.4. Kate and Sam are considering an income-sharing agreement. Under this legally binding agreement, the two people will agree to split their combined incomes evenly.
a. If each person is risk-neutral, will both of them be willing to sign the agreement? Why or why not?
b. Instead, suppose that each person has a utility function over income given by U(M)=M^0.5, where M represents income. Will both people be willing to sign the agreement? Why or why not?
c. Suppose instead they try to establish an agreement under which x% of the combined income goes to Sam and the remainder goes to Kate. What is the lowest value of x such that Sam would still accept the contract? Will the two people both be willing to enter an agreement?
