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lecture07_slides

lecture07_slides - Econ 121 Intermediate Microeconomics...

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Econ 121. Intermediate Microeconomics. Eduardo Faingold Yale University Lecture 7
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Outline of the course I. Introduction II. Individual choice III. Competitive markets IV. Market failure
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Outline of the course I. Introduction II. Individual choice ± Budget constraint (Ch. 2) ± Preferences (Ch. 3) ± Utility (Ch. 4) ± Consumer problem (Ch. 5) ± Revealed preference (Ch. 7) ± Slutsky equation (Ch. 8) ± Endowment income effect (Ch. 9) ± Intertemporal choice (Ch. 10) ± Choice under uncertainty (Ch. 12) III. Competitive markets IV. Market failure
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Demand for Insurance ± Suppose consumer initially has $ 35;000 in wealth . ± But his final wealth is uncertain and he may loose $ 10;000 , say, because his car may be stolen. ± An insurance contract the consumer can buy pays him $ 1 in case the loss occurs. To buy insurance the consumer must pay upfront a premium of ± dollars per contract he buys. ± How much insurance will the consumer buy, if any? ± How do we even approach this problem?
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Demand for Insurance ± Consumer decides how many contracts to buy ± If he buys K insurance contracts his final wealth is: w 0 D ( 25;000 C K NUL ±K W car stolen 35;000 NUL ±K W car not stolen ± To simplify matters, assume there is only one consumption good so that consumer cares directly about wealth . (In reality, with two or more goods, wealth matters indirectly because of its effect in the final decision of which bundle to consume.) ± Different choices of K yield different contingent consumption plans . ± How do we extend consumer theory to deal with choice under uncertainty?
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In terms of standard consumer theory... ± There is a way to translate this problem into standard consumer theory. ± Two states of nature : state 1 (car stolen) and state 2 (car not stolen). ± A bundle is .x 1 ; x 2 / , that is, consumption (of the same good!) in each state. ± That is, we allow the consumer to choose different amounts of a good contingent on the state.
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