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Unformatted text preview: Intermediate Microeconomics 301 UBC Sergei Severinov Lecture notes Uncertainty, Risk DecisionMaking and Choice under Uncer tainty 1 Topics: Risk and Uncertainty Attitude Towards Risk and Uncerainty The Demand for Insurance and Risky Assets 2 Choice under uncertainty Uncertainty in a pervasive feature of the economic life. Many events and out comes of actions are random: may or may not occur (good or bad weather for the agriculture), or may take different values (prices, incomes). Main questions: (1) How to describe uncertainty? (2) How the economic actors i.e. firms and individuals take the decisions under uncer tainty? (3) How to describe preferences over ran dom events? (4) What is the effect of uncertainty on the individuals, on their utility (welfare) and their choices? (5) What is the effect of risk? 3 Probability and Probability Distribu tion. States of the World First task: develop a common lan guage to deal with different types of un certainty and describe them in a universal way. The most convenient description of the random events can be given by using the following concepts: (i) random variable (ii) the state of the world (iii) probability distribution random variable is a common name for the thing that we are studying (weather, price, income) and the value of which is random (uncertain) and will be realized in the future. A random variable is synony mous with uncertainty. 4 Definition. A possible realization (out come) of a random variable is called a state of the world . For example, if prices tomorrow can take integer values from 1 to 10, then there are 10 possible states of the world tomor row each corresponding to a different price. When price turns out to be equal to p i , we say that the state of the world correspond ing to p = p i has occurred. 5 Suppose that the variable x which we are studying (next years crop, your starting salary after graduation, the loss or win in the casino) is uncertain can take n possible values x i i = 1 ,...,n . Let i be the probability that out come x i occurs. Note that i 0 and i = n i =1 i = 1. Then { 1 , 2 ,.., n } is called the probability distribution. It describes how the probabilities with which possible values of x are distributed. Often, we will write ( . ) as a function of the realization of x . Interpretation: the probability that the variable x takes value x i is given by ( x i ) = i 6 Consider some random variable x . Sup pose that we know that it has possible re alizations x i , i = 1 ,...,n , and corresponding probabilities i . (i.e. we know its probabil ity distribution). Main characteristics of a random vari able are expected value and variance....
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This note was uploaded on 01/28/2011 for the course ECON 301 taught by Professor Chapple during the Spring '08 term at The University of British Columbia.
 Spring '08
 CHAPPLE
 Microeconomics

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