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Unformatted text preview: Economic Decisions under Risk Many economic decisions involve risk... buying car / home insurance; saving for retirement; deciding on a production plan for your &rm; participating in a joint venture; investing in R¡D; hiring a manager... Ani Guerdjikova ECON 313 Fall 2007 241 / 267 Economic Decisions under Risk Modelling decisions under risk We model risk by assuming uncertainty about the outcome of a speci&c action, e.g. Ani Guerdjikova ECON 313 Fall 2007 242 ¡ 267 Economic Decisions under Risk Modelling decisions under risk We model risk by assuming uncertainty about the outcome of a speci&c action, e.g. a given production plan x can lead to di/erent outputs y 1 ; y 2 ... y n depending on market conditions, weather, political situation, etc. Ani Guerdjikova ECON 313 Fall 2007 242 ¡ 267 Economic Decisions under Risk Modelling decisions under risk We model risk by assuming uncertainty about the outcome of a speci&c action, e.g. a given production plan x can lead to di/erent outputs y 1 ; y 2 ... y n depending on market conditions, weather, political situation, etc. a given portfolio of assets a can lead to di/erent returns r 1 ; r 2 ... r n depending on the state of the economy, interest rates, performance of individual &rms, etc. Ani Guerdjikova ECON 313 Fall 2007 242 ¡ 267 Economic Decisions under Risk Modelling decisions under risk (contd.) We assume that economic agents know the probability with which each of these outcomes occurs, e.g. Ani Guerdjikova ECON 313 Fall 2007 243 / 267 Economic Decisions under Risk Modelling decisions under risk (contd.) We assume that economic agents know the probability with which each of these outcomes occurs, e.g. production plan x leads to output of y 1 = 150 with probability 1 3 and to an output of y 2 = 300 with probability 2 3 Ani Guerdjikova ECON 313 Fall 2007 243 / 267 Economic Decisions under Risk Modelling decisions under risk (contd.) We assume that economic agents know the probability with which each of these outcomes occurs, e.g. production plan x leads to output of y 1 = 150 with probability 1 3 and to an output of y 2 = 300 with probability 2 3 portfolio a has a return of r 1 = 50 % with probability 1 10 , a return r 2 = 10 % with probability 1 2 and a return r 3 = 5 % with probability 2 5 . Ani Guerdjikova ECON 313 Fall 2007 243 / 267 Economic Decisions under Risk Modelling decisions under risk (contd.) We assume that economic agents know the probability with which each of these outcomes occurs, e.g. production plan x leads to output of y 1 = 150 with probability 1 3 and to an output of y 2 = 300 with probability 2 3 portfolio a has a return of r 1 = 50 % with probability 1 10 , a return r 2 = 10 % with probability 1 2 and a return r 3 = 5 % with probability 2 5 ....
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This note was uploaded on 04/30/2008 for the course ECON 3130 taught by Professor Masson during the Fall '06 term at Cornell.
 Fall '06
 MASSON
 Microeconomics

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