In a court case, a plaintiff claimed that the defendant should pay her $3 million for dam- ages. She did not expect the judge to award her this amount; her expected value actually was $1 million. The defendant also did not believe that the court would award the full

$3 million, and shared the plaintiffs expected value of $1 million.

a Assuming that the plaintiff is thinking about the award in terms of gains, explain why you might expect her to be risk-averse in this situation. If she is risk-averse, what kind of settlement offer might she accept from the defendant?

b Assuming that the defendant is thinking about the situation in terms of losses, ex- plain why you might expect him or her to be risk-seeking. What would this imply about settlement offers to which the defendant might agree? (Hint: Draw an example of a risk-seeking utility curve over the possible negative payoffs for the defendant. Now find the certainty equivalent.)

c Discuss your answers to parts a and b. What are the implications for settlements in real-world court cases? What would happen if the defendants expected value were less than the plaintiffs?