PRMIA Exam 8006 Topic 1 Question 5 Discussion

Remember the four basic axioms underlying the principal of maximum expected utility:

- Transitivity, ie if A is preferred over B, and B is preferred over C, then A must be preferred over C;

- Continuity, ie if A is preferred over B, and B is preferred over C, then B is on a continuum between A and C such that we can be indifferent between receiving B, or a lottery offering either A or C with probabilities p & 1-p respectively.

- Independence, ie choices are not affected by the way they are presented

- Stochastic dominance, ie a gamble that offers a greater probability of a preferred out come will be preferred.

In this case, the first axiom is being violated. Therefore Choice 'c' is the correct answer.