204_summer_2009_lecture_22

# 204_summer_2009_lecture_22 - University of Toronto...

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University of Toronto Department of Economics ECO 204 Summer 2009 Sayed Ajaz Hussain Lecture 22 1 S. Ajaz Hussain. sayed.hussain@utoronto.ca

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Last Time ± Models of Oligopoly ± Cournot Oligopoly ² Firms choose output simultaneously ² Market price depends on total output ± Stackelberg Oligopoly ² Firms choose output sequentially ² Market price depends on total output ± Bertrand Oligopoly ² Firms choose prices ² Firms sell corresponding output 2 Contrast with monopoly and perfect competition
Today ± Probability: 3 interpretations and rules ± Criteria for decision making under uncertainty ± Expected Value ± Is crime “rational”? ± Expected Utility ± Attitudes towards Risk ± Certainty Equivalence ± Deriving utility function S. Ajaz Hussain. sayed.hussain@utoronto.ca 3

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Probability Rules: ± 0 P(Event) 1 ± Probability of all outcomes = 1 ± If events A and B are “independent” then: ± P(Event A and Event B) = P(Event A) P(Event B) S. Ajaz Hussain. sayed.hussain@utoronto.ca 4 Probability “Objective” or “Natural” “Frequency” “Subjective” or “Bayesian”
Example S. Ajaz Hussain. sayed.hussain@utoronto.ca 5 123456 Heads Tails Probability of observing any single outcome = Probability of observing all outcomes = Probability of observing Heads and 4 =

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Criteria for Decision Making ± There is a plethora of making decisions under uncertainty ± Focus on “Expectation” rules in economics and finance ² Depends on decision maker’s attitudes towards risk ² Risk Neutral o Uses Expected Value (EV) or Expected Utility (EU) ² Risk Averse o Uses Expected Utility (EU) ² Risk Loving o Uses Expected Utility (EU) ± Other rules: ² Standard deviation (risk), min max, coefficient of variation etc S. Ajaz Hussain. sayed.hussain@utoronto.ca 6
Risk Neutral, Risk Averse, Risk Loving S. Ajaz Hussain. sayed.hussain@utoronto.ca 7 \$ \$ \$ Utility Utility Utility Risk Neutral Risk Loving Linear Utility Function dU(X)/dX > 0 d 2 U(X)/dX 2 = 0 Concave utility Function dU(X)/dX 0 d 2 U(X)/dX 2 0 Convex Utility Function dU(X)/dX > 0 d 2 U(X)/dX 2 0 Risk Averse

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## This note was uploaded on 05/02/2011 for the course ECO 204 taught by Professor Hussein during the Fall '08 term at University of Toronto- Toronto.

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204_summer_2009_lecture_22 - University of Toronto...

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