2025 ASR-VJC-TJC H3 Economics Prelim Suggested Answers

[Turn over 2025 ASRJC H3 prelim paper Suggested answers Question 1 (a) With reference to Extract 1, explain how different risk attitudes influence individuals’ decisions towards cryptocurrency investments. Assume the following payoffs: 1. An individual gets a guaranteed investment income of $5,000 from a fixed deposit commitment. 2. There is a 50 per cent chance he gets absolutely nothing, and a 50 percent chance that he gets $10,000 from cryptocurrency investment. In the second scenario, his expected investment income is thus 0.5 × $0 + 0.5 × $10,000 = $5,000. There are three types of individuals: (i) risk-averse, (ii) risk-neutral, and (iii) risk- loving. Note: risk-neutral not discussed here. Risk-averse individuals prefer outcomes with lower uncertainty and tend to avoid high levels of risk, even if the potential rewards are significant. Risk- averse individuals have a concave utility function. The individual has a higher level of utility from an investment income of $5000 (utility at 12) with certainty from fixed deposit than if he had to take a chance with cryptocurrency investment (utility at 10). His risk premium is $1500. Decisions towards cryptocurrency investments: These individuals tend to avoid investing in cryptocurrencies due to their high volatility and uncertain returns. They are more likely to prefer traditional, lower- risk investments like government bonds or savings accounts. The utility derived from potential high returns does not outweigh the disutility caused by the perceived high risk and potential for losses. This aligns with the diminishing marginal utility of (investment) income — the additional satisfaction from gains in income decreases as income increases, making losses more impactful. Extract 1 suggested that lower income individuals tend to be more risk-averse. Risk-loving individuals prefer investments with higher risk as they derive utility from taking risks. Moreover, these investors are drawn by the lure of potentially higher returns in a “lottery-style payoff” than investors expect with traditional investments. Risk-seeking individuals have a convex utility function. [6]

[Turn over 2 The risk-loving individual has an increasing marginal utility of (investment) income. This means that the additional utility per dollar (investment) income gained gets higher and higher. The risk-loving individual thus always prefers the uncertain outcome (utility of 10) from crypto investments than the certain outcome (utility of 5) from fixed deposit. Decisions towards cryptocurrency investments: These individuals are attracted to the speculative nature of cryptocurrency markets, including high-risk, high-reward investments, or investments in unproven cryptocurrencies. Mark scheme Level Knowledge, Application, Understanding and Analysis Mark L3 For a well-developed answer that has: • good scope – explain how different risk attitudes (high risk a