Microeconomics · free preview
Decisions under Uncertainty
Risk-averse people maximize expected utility, not expected value, diminishing marginal utility makes fair gambles unattractive, and the risk premium measures what insurance is worth.
1. Two ways to value a gamble
Two ways to value a gamble
2. The risk premium
The risk premium
3. Diversification
Diversification
4. From tools to behavior
From tools to behavior
5. Expected utility logic
With concave utility of wealth, why does a fair coin flip for plus or minus 50 dollars reduce expected utility below the utility of staying put?
6. Reading the premium
A homeowner's expected utility from a risky year equals the utility of 96 thousand for certain, while expected wealth is 100 thousand. What does the 4 thousand difference represent?
7. A fair gamble's expected value
A coin flip pays 50 dollars on heads and loses 40 dollars on tails. Compute the expected value in dollars, and write the number.
8. The shape that says no
With concave utility of wealth, why does a fair coin flip for plus or minus 50 dollars reduce expected utility?
9. Pricing the escape from risk
What is a risk premium in this framework?
10. A richer coin flip
A coin flip pays 70 dollars on heads and loses 30 dollars on tails. Compute the expected value of the gamble in dollars, and write the number.
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