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section7_1

# section7_1 - Department of Economics University of...

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Department of Economics University of California, Berkeley ECON 100A Spring 2010 - Section 7 GSI: Antonio Rosato Risk and Uncertainty This topic is an effort by economists to more accurately describe consumer behavior in the real world. We say that a consumer (or a producer, or anyone) faces uncertainty when he does not know exactly what will happen at some future time. In the context of this class, this could be for example not knowing what will the prices we face and our income be in a future period. We use the concept of risk to describe quantified uncertainty, but they can be used interchangeably. Quantifying risk We have a risky situation when there is more than one possible future outcome. We can quantify this if we know what is the probability of occurrence for each outcome. How do we know what these probabilities are in real life? It could be just a guess, but it could also be deduced from past events, from the frequency of their occurrence: We denote the probability of an outcome i by Pr i = n i /N , where n i is occurrences of that outcome, and N is total number of events. Knowing all the probabilities of all the outcomes gives us a probability distribution, i.e. a percentage associated with each outcome. The probabilities of all outcomes must sum to 1. The probability distributions we will be looking at in the examples will have only two possible events, each with a different probability. We will use three measures

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