20.6 : Risk Neutral and Risk Loving

Individuals make decisions based on their preferences toward risk. A risk-neutral person has constant marginal utility of income. This means that each additional unit of income provides the same increase in satisfaction. Suppose two jobs have the same expected income. However, one job provides a fixed salary which is certain, while the other offers an uncertain salary. A risk-neutral person values both options equally because their total expected utility from each is the same. Therefore, they remain indifferent between the two.

In contrast, a risk-loving person has increasing marginal utility of income. This means that each additional unit of income provides a greater increase in satisfaction than the previous one. Suppose two jobs have the same expected income. However, one job provides a fixed salary, which is certain, while the other offers an uncertain salary. A risk-loving person prefers an uncertain job because the potential for higher earnings gives them more satisfaction. This means that they choose the riskier option.

The degree of risk preference influences financial and career choices, shaping how people respond to uncertain but potentially rewarding outcomes.