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lecture_10 - Uncertainty States of Nature Possible states...

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ECOS2001 Lecture 10 1 Uncertainty States of Nature Possible states of Nature: “car accident” (a) “no car accident” (na). Accident occurs with probability π a, does not with probability π na ; π a + π na = 1. Accident causes a loss of $L. Contingencies A contract implemented only when a particular state of Nature occurs is state-contingent. E.g. the insurer pays only if there is an accident.
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ECOS2001 Lecture 10 2 State-Contingent Budget Constraints Each $1 of accident insurance costs γ . Consumer has $m of wealth. Cna is consumption value in the no-accident state. Ca is consumption value in the accident state Without insurance, Ca = m – L Cna = m.
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