Consumer Theory 8

# Consumer Theory 8 - Economics 21 Intermediate...

This preview shows pages 1–9. Sign up to view the full content.

Economics 21 Intermediate Microeconomics Topic 2: Consumer Theory (viii) Risk & Uncertainty

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
I. Introduction We have so far assumed that the world is certain This is a bit … silly? This world is inherently uncertain The same people who insure their cars and houses also but lottery tickets and play bingo! Why?
II. Uncertainty Assume that there are two states of the world State 1: Wealth = w 1 State 2: Wealth = w 2 = w 1 - L where L > 0 occurs with probability p > 0 Expected wealth: w = 1- π ( 29 ϖ 1 + πϖ 2

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
II. Uncertainty Expected wealth: ( 29 ( 29 ( 29 1 2 1 1 1 1 1 1 1 1 w p w pw w p w p w L w w pw pw pL w w pL = - + Þ = - + - Þ = - + - Þ = -
II. Uncertainty Individuals are not interested in wealth per se , but in the utility of wealth This is an important distinction; an increase in wealth of £100 is unlikely to change the utility of a prince (David Beckham? A-Rod?) and a pauper (me!) by the same amount Assume individual’s utility function is u = u ( w ) Individual’s objective is to maximise expected utility, not expected wealth!

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
II. Uncertainty Utility function: We assume that total utility increases with wealth such that marginal utility is positive: u = υ ϖ ( 29 du dw = υ ϖ ( 29 0
II. Uncertainty Expected Utility: Add and subtract u ( w 2 ) ( 29 ( 29 ( 29 1 2 1 u p u w pu w = - + ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 2 1 2 2 2 1 2 1 1 u u w p u w pu w u w u u w p u w u w = + - + - Þ é ù = + - - ë û

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
II. Uncertainty
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern