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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 Spring '08
 Woroch
 Economics, Utility, San Diego, Bay Area

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