Question

Let's consider a simple example of moral hazard. Suppose that Woodrow goes into a casino to make one bet a day. The casino is very basic - it has two bets: a safe bet and a risky bet. The safe bet is the following: a nickel is flipped. If the nickel lands on "heads," Woodrow wins $100. If it lands on "tails," Woodrow loses $100. The risky bet is similar: a silver dollar is flipped. If the silver dollar lands on "heads," Woodrow wins $5,000. If it lands on "tails," Woodrow loses $10,000. Each coin has a 50% chance of landing on each side.

What is the expected value of the safe bet?
$_____Number

Answer 1

The expected value of the safe bet is $0, which means that over the long run, Woodrow is expected to break even. if Woodrow continues to make the safe bet, he is expected to break even.

Step-by-step explanation:

The expected value of a bet is the sum of the products of the possible outcomes and their respective probabilities. In this case, the safe bet has two possible outcomes: winning $100 and losing $100. Each outcome has a probability of 0.5 (50%). So, the expected value of the safe bet can be calculated as:

Expected value = (probability of winning * amount won) + (probability of losing * amount lost)
Expected value = (0.5 * $100) + (0.5 * -$100)
Expected value = $50 + (-$50)
Expected value = $0

This means that the expected value of the safe bet is $0. In other words, over the long run, if Woodrow continues to make the safe bet, he is expected to break even.