Extra Midterm Question #7

[Guneet]

How do we know that they are risk neutral?

I know rise averse is pi=r

Are there extra rules for this?

[J]

The second derivative of a risk neutral individual's utility function U(c) is U''(c) = 0.

This is because their IDC's slope is constant and doesn't change. 

Unlike risk averse individuals, who have a negative second derivative (a decreasing MRS and convex curve) 

U''(c) < 0

and risk lovers, who have a positive second derivative (an increasing MRS and concave curve).

U''(c) > 0

[Lindsay Appell]

Perfect! You can also graph out the utility function (with wealth on the x-axis and utility on the y-axis) and use the shape to determine whether they are risk neutral, risk averse, or a risk lover.