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Fitch%20-%20Class4%20F10-%20Risk

Fitch%20-%20Class4%20F10-%20Risk - Chapter 5 Uncertainty...

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er Behavior Fall 2010 UGBA101A-03 Microeconomic Analysis for Business Decisions Chapter 5 Uncertainty and Consume Slide 1 Class 4 Prof. Todd Fitch

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er Behavior CHAPTER 5: Uncertainty and consumer behavior Agenda What is risk? How can we measure it? How can we reduce it? Chapter 5 Uncertainty and Consume Slide 2 Attitudes towards risk
er Behavior Uncertainty and Consumer Behavior 1. Heads you get U\$S 3 and tails you get nothing 2. Heads you get U\$S 2 and tails you get U\$S 1 Which of these lotteries would you choose? How much are you willing to pay to participate in the first one? How about the second one? Chapter 5 Uncertainty and Consume Slide 3

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er Behavior Uncertainty and Consumer Behavior 1. Heads you get U\$S 10 and tails you get nothing 2. Heads you get U\$S 6 and tails you get U\$S 4 Which of these lotteries would you choose? How much are you willing to pay to participate in the first one? How about the second one? Chapter 5 Uncertainty and Consume Slide 4
er Behavior DESCRIBING RISK 5.1 Lotteries outcomes Things that can happen X 1 , X 2 , . . . X n probability Likelihood that a given outcome will occur Pr 1 , Pr 2 , . . . Pr n Payoff Value associated with a possible outcome Measuring risk Chapter 5 Uncertainty and Consume Slide 5 uni25CF expected outcome Probability-weighted average of all possible outcomes. E ( X ) = Pr 1 X 1 + Pr 2 X 2 + . . . + Pr n X n uni25CF outcome variance Probability-weighted average of the square difference between possible outcomes and the expected outcome. Var ( X ) = Pr 1 (X 1 -E(X))^2+ Pr 2 ( X 2 -E(X))^2+ . . . + Pr n (X n -E(X))^2

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er Behavior DESCRIBING RISK 5.1 Expected Value - Example The expected value measures the central tendency— the payoff or value that we would expect on average. Expected value = Pr(success)(\$40/share) + Pr(failure)(\$20/share) = (1/4)(\$40/share) + (3/4)(\$20/share) = \$25/share Chapter 5 Uncertainty and Consume Slide 6
er Behavior DESCRIBING RISK 5.1 Variability uni25CF variability Extent to which possible outcomes of an uncertain event differ. OUTCOME 1 OUTCOME 2 Probability Income (\$) Probability Income (\$) Expected Income (\$) Job 1: Commission Job 2: Fixed Salary .5 2000 1000 .5 1500 TABLE 5.1 Income from Sales Jobs Chapter 5 Uncertainty and Consume Slide 7 uni25CF deviation Difference between expected payoff and actual payoff. .99 1510 510 .01 1500 TABLE 5.2 Deviations from Expected Income (\$) Outcome 1 Deviation Outcome 2 Deviation Job 1 Job 2 2000 1510 500 10 1000 510 - 500 - 990 uni25CF standard deviation Square root of the weighted average of the squares of the deviations of the payoffs associated with each outcome from their expected values.

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er Behavior
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Fitch%20-%20Class4%20F10-%20Risk - Chapter 5 Uncertainty...

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