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Section4

# Section4 - Aniko Oery University of California Berkeley...

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Aniko Oery University of California, Berkeley Section 4: Decision under uncertainty Econ 100A, MICRO-ECONOMIC ANALYSIS, Spring 2010 Before we continue with the analysis of decision making in the case of two goods, we will analyze preferences of decision makers under risk. Since the consideration of risk makes our models more complicated, we focus on situations where people only care about one good, namely money. Hence, we restrict ourselves to univariate utility functions. 1 Lotteries A lottery X is defined by monetary payoffs and probabilities with which each payoff occurs. In mathematics lotteries are also called random variables. One can represent the distribution of a random variable or lottery graphically using a histogram as you have seen in lecture. Example: X = \$ - 10 with probability 0 . 5 \$0 with probability 0 . 2 \$20 with probability 0 . 3 Would you play this lottery with me? 2 vonNeumann-Morgenstern utility functions

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