2Today’s AgendaChapter 5. Choice under Uncertainty1. How to describe an uncertain outcome2. How to compare different outcomes– Expected value– Expected utility3. Preference toward risk4. Reducing risk:– Diversification– Insurance– Obtaining more information (next lecture)
3Introduction• If the outcome is certain, the choice is simple: choose the action that gives the highest payoff– Certain action A: payoff $100– Certain action B: payoff $80– Choice: A• How do we choose when the outcome is uncertain?– Action A with a certain outcome: net payoff $100– Action B with an uncertain outcome: $80 (with prob. ½) and $140 (with prob. ½)– Choice?
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