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Class 20-2010

# Class 20-2010 - C295 Class 20 Uncertainty and Information...

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11/22/2010 1 THE UNIVERSITY OF BRITISH COLUMBIA C295: Class 20 – Uncertainty and Information 1 Today: 1. Review questions on choice under uncertainty 2. Problems with decision-making under uncertainty 3. Framing Effects 4. Other biases and inconsistencies in choice under uncertainty 5. Asymmetric information 6. Adverse Selection (the “Lemons Problem”) 7. Summary THE UNIVERSITY OF BRITISH COLUMBIA Clicker Question 1 2 a) A risk neutral person has a positive risk premium. b) A risk averse person may have a negative or positive risk premium. c) A concave utility function always implies a positive risk premium. d) The risk premium shows how much risk a risk-seeking person is willing to take on. e) None of the above. The risk premium is defined in the textbook as the amount someone would pay to avoid a particular risk. Equivalently, it is the amount someone would have to receive in extra expected value to be willing to take on a particular risk. Which of the following statements is true?

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11/22/2010 2 THE UNIVERSITY OF BRITISH COLUMBIA Clicker Question 2 Investment Return with Bad Luck Return with Good Luck Probability of Bad Luck Probability of Good Luck A55 0 . 6 0 . 4 B28 0 . 5 0 . 5 C 0 12 0.5 0.5 Assume the investor cares only about expected value and variance. Which statement is true? a. A risk neutral investor would be indifferent over all three investments. b. A risk averse inverse could never prefer investment C. c. A risk seeking investor would prefer investment B. d. All of the above. e. None of the above. THE UNIVERSITY OF BRITISH COLUMBIA 2. Problems in Decision-Making: Question I A new infectious disease is expected to kill 600 people if no action is taken. The government is considering two alternative programs to combat the disease. The “exact scientific estimates” of the consequences of these programs are: If Program A is adopted, 200 people will be saved. If Program B is adopted, there is a 1/3 probability that all 600 people will be saved and a 2/3 probability that no one will be saved. Which program do you prefer? a. Program A b. Program B 4
11/22/2010 3 THE UNIVERSITY OF BRITISH COLUMBIA Question II A new infectious disease is expected to kill 600 people if no action is taken. The government is considering two alternative programs to combat the disease. The “exact scientific estimates” of the consequences of these programs are: If Program C is adopted, 400 people will die.

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Class 20-2010 - C295 Class 20 Uncertainty and Information...

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