Alex, who is risk-neutral, is looking for an one-bedroom apartment to rent for the month of August while he's on vacation in Seattle. All of the one-bedroom apartments in the neighborhood where he wants to stay are of equal quality, but 70 percent rent for $700 per month, 20 percent rent for $600 per month, and 10 percent rent for $500 per month. The first apartment Alex finds rents for $700 per month. If the cost to Alex of searching for an apartment is $40, then searching for another apartment is a gamble with an expected value of:

a. - $10.

b. $0.

c. $10.

d. $20.

Question

Trevor Baxter

Business

27 May, 18:08

Alex, who is risk-neutral, is looking for an one-bedroom apartment to rent for the month of August while he's on vacation in Seattle. All of the one-bedroom apartments in the neighborhood where he wants to stay are of equal quality, but 70 percent rent for $700 per month, 20 percent rent for $600 per month, and 10 percent rent for $500 per month. The first apartment Alex finds rents for $700 per month. If the cost to Alex of searching for an apartment is $40, then searching for another apartment is a gamble with an expected value of:

a. - $10.

b. $0.

c. $10.

d. $20.

+2

Answers (1)

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Nathalia Powers · Answer 1

b. $0.

Explanation:

We need to find the expected value of the gamble which is compared to $700. Given that there is apartments where 70 percent rent for $700 per month, 20 percent rent for $600 per month, and 10 percent rent for $500 per month. The cost to Alex of searching for an apartment is $40.

Expected cost of searching the next apartment = 700*0.7 + 600*0.2 + 500*0.1 + 40 = $700.

Now the first apartment has a rent of $700 and the expected cost of searching the next apartment is also $700. This implies the gamble has an expected value of $0 and Alex is indifferent between searching or non searching.