Lecture notes
ECON0040 Week 2
- Module
- Economics (ECON0040)
- Institution
- University College London (UCL)
In depth notes on ECON0040 Week 2
[Show more]
Seller
Follow
Content preview
Week 2Decision Making Under Risk and Uncertainty
Introduction
Risk- we can accurately calculate the probability that something will happen, the probability
distribution of outcomes is known objectively (eg. Lottery)
Uncertainty- the probability distribution of outcomes is unknown (eg. Horse racing)
Lotteries
1) Simple lottery
N possible outcomes
X G xn
with a probability distribution over outcomes
can be represented by a lottery Pi Pn whereEntpn l
L ien
eg. X 100,107,4 025,075 X 100,101,4p105.0.5
2) Compound lottery
a list Li Leia ae
where is the probability of lottery k occurring andEYand
ar
eg. L L20.2.0.8
This can be transformed into a reduced lottery a tank
Eg. X 100,107,410.250.751 x 100,101,2210.50si
Lit
4,2202,08
o.zxo.zsto.sxo.so.es l ottery
Reduced
p o.zxo.zsto.sxo.s o.se x100,101,210.450.54
B
Expected value of a lottery:111
11 II pix exittenXn
St. Petersburg Paradox
• You have an initial endowment of £1
• You ip a coin until it is tails, if it is heads your endowment doubles
• You win the endowment when it comes up tails for the rst time
How much would you pay to play:
EV 42 2 444thnk H n n
I 42
Royd
2 Y Pyg's
114
I
k i Yar
As a result of this, Bernoulli proposed that people should maximise expected utility not expected
value
Preferences over lotteries
Let
E denote the decision maker’s preference relation on L (The set of all simple lotteries)
The decision maker has preferences over lotteries on some nite price space X
Only the reduced form lottery over nal outcomes is if relevance to the decision maker
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller zctpfru. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £7.16. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
64438 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy revision notes and other study material for 14 years now