(The Allais Paradox) Suppose we are offered a choice between the following two lotteries: L 1 : With

(The Allais Paradox) Suppose we are offered a choice between the following two lotteries:

L1:

With probability 1, we receive $1 million.

L2:

With probability .10, we receive $5 million.

 

With probability .89, we receive $1 million.

 

With probability .01, we receive $0.

Which lottery do we prefer? Now consider the following two lotteries:

L3:

With probability .11, we receive $1 million.

 

With probability .89, we receive $0.

L4:

With probability .10, we receive $5 million.

 

With probability .90, we receive $0.

Which lottery do we prefer? Suppose (like most people), we prefer L1 to L2. Show that L3 must have a larger expected utility than L4.

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