7-Uncertainty (I)

7-Uncertainty (I) - Agenda Course Overview Describing Risky...

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1 Agenda • Course Overview • Describing Risky Situations • Preferences Toward Risk • Managing Risk: Insurance • What To Take Away Microeconomics The Structure of the Course Consumers and Producers Market Interaction Today’s lecture Uncertainty Perfect competition Monopoly and Pricing strategies Competitive Strategy Auctions Information in Markets and Agency Game Theory Introduction to Markets Consumer Theory and Demand Technology and Production
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2 Uncertainty Uncertainty is a pervasive feature of economic life: Investing in the stock market, A new Harry Potter movie is out on the movie theaters. Should I watch it or not? Your thinking about the trip of your lifetime: going to Everest Base Camp to see the highest mountain in the world. What’s the weather going to be like? We need to find answers to the following questions How can we describe uncertainty ? How to describe risk ? How does uncertainty affect the behavior of economic actors? In particular: How do we make choices when the consequences of our choices maybe uncertain? How can we characterize the preferences of a consumer over uncertain choices. For instance, how would you decide to invest or not in shares of Apple? It is hard to know what new products will be delivered in the future and whether those products are successful or not. However at the time of your decision, the future of Apple is uncertain to you. More generally, should you invest in in safer assets (like treasury bonds) or on riskier assets (shares on the stock market)? Uncertainty
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3 Agenda • Course Overview • Describing Risky Situations • Preferences Toward Risk • Managing Risk: Insurance • What To Take Away Describing uncertain outcomes First, we need to describe a risky choice. In order to do so we need to know: All of the possible outcomes or consequences of our choice. The probability or likelihood that each outcome will occur. 10% 90%
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4 Describing probabilities over outcomes Objective Probability Based on physical properties of the random activity. Based on the observed frequency of past events Subjective Probability Based on perception that an outcome will occur. Different information or different abilities to process the same information can influence the subjective probability. Based on judgment or experience. Once we have outcomes and probability how do we compare options involving uncertain outcomes? We will determine 2 characteristics to help describe and compare risky choices Expected value Variability Describing risky situations
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5 Expected value is the weighted average of the payoffs or values resulting from all possible outcomes, where the weights are the probability of each outcome. Expected value measures the central tendency: the payoff
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7-Uncertainty (I) - Agenda Course Overview Describing Risky...

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