BE 10 CHOICES UNDER RISK I.pptx

# Amount of taiwanese food youll eat how much youll

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Amount of Taiwanese food you’ll eat? How much you’ll actually learn? Will you make a lot of friends? Will you get a job after graduation? List the outcomes you considered.

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Simple Choices A degree from MCU in Taiwan A degree from University B in Country B What is the value of each? The utility ?
Choices MCU in Taiwan University B in Country B Did you think about how likely these outcomes were? The probabilities? How much weight did you assign to the likelihood of each outcome actually occurring?

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Risky Choices How should you make a choice when risk is involved? How do you make a choice when risk is involved?
Risky Choices Expected Values, Expected Utility & Prospect Theory

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Expected Value Theory (pre-1738)
Coin Flip: What are the possible outcomes? What are the values and probabilities of these outcomes ? 50% chance to win \$10 and 50% chance to lose \$10.

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Imagine flipping a fair coin thousands of times. How much would you expect to win or lose? 50% chance to win \$10 and 50% chance to lose \$10.
GROUPS: For any outcome for which you know the values and the probabilities of the outcomes, how can you calculate the expected value ? X% chance to win \$A and Y% chance to lose \$B.

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Expected Value – Sum of the probability-weighted values. 0.5 x 10 = 5 0.5 x -10 = -5 Expected Value = \$0
Choose one of the below. 80% chance to win \$100 and 20% chance to win \$10. USD \$80

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Imagine playing a game with these odds 1000 of times. What would you expect the average value of each game to be? 80% chance to win \$100 and 20% chance to win \$10.
You would probably win \$100 800 times, giving you 800 x \$100 = \$80,000 You would probably win \$10 200 times, giving you 200 x \$10 = \$2,000. Your total would be 82,000 over 1000 games, so your average per game would be \$82. 80% chance to win \$100 and 20% chance to win \$10.

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If you could play 1000 times, which should you choose? If you can only play once, which would you choose? 80% chance to win \$100 and 20% chance to win \$10. USD \$80
80% chance to win \$100 and 20% chance to win \$10. USD \$82 USD \$80

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Risky Choices Based on expected values, choose the 80%-20% option
Is this how we really make choices?

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What should you do according to Expected Value Theory IS THAT WHAT YOU REALLY WOULD DO? 50-50 chance to have \$1 million or \$7 million. EV = \$? \$4 million
You should be indifferent – willing to accept either one Are you? 50-50 chance to have \$1 million or \$7 million. EV = 4 million \$4 million

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Expected Utility Theory Daniel Bernoulli (1700-1782)

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