lec15 - Time and Uncertainty We don't know the future. We...

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4 Time and Uncertainty • We don’t know the future. • We must make decisions whose outcome depends on unknown future events. • We can take actions that reduce or increase the uncertainty. 5 Two concepts: • Von Neumann-Morgenstern utility • Expectations over future events 7 Von Neumann-Morgenstern Utility Our well-being increases with our buying power (income, wealth, or net assets.) “Utility” is a function of buying power: y = income, wealth or net worth U(y) = utility from y 8 Utility Y Utility rises with y. 10 Utility Y Extra income has large effect when poor. Extra utility 12 Utility Y Extra income has smaller effect when rich. Extra utility
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15 Expected Values over Uncertain Events Example: two possible futures Good luck gives Y G Bad luck gives Y B Expected income: EY = Prob(Good luck) * Y G + Prob(Bad luck) * Y B 16 Probability of good luck = 0.50 Y G = 100,000 Y B = 50,000 EY = 0.50 * 100,000 + 0.50 * 50,000 = 75,000 17 Probability of good luck = 0.80 Y G = 100,000
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This note was uploaded on 04/03/2008 for the course ECON 1 taught by Professor Martholney during the Fall '08 term at University of California, Berkeley.

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lec15 - Time and Uncertainty We don't know the future. We...

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