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L12

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Certainty equivalent of lottery. Example. Example. Risk Aversion: Choice of Insurance ... Free Entry and Law of Large Numbers. Insurance. Bernoulli utility, ... – PowerPoint PPT presentation

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Title: L12


1
L12
  • Buying and Selling Uncertainty

2
Three Applications
Model with real endowments 1. Labor Supply
(Labor-Leisure Choice) 2. Intertemporal Choice
(Consumption-Savings Choice) 3. Uncertainty
(Insurance) (Consumption across states of the
world)

3
Uncertainty
  • Two States of the world no rain and rain
  • Probabilities
  • Goods consumption
  • Endowment income in two states and states
  • Possibility of insurance

4
Uncertainty and Lotteries
5
Uncertainty
  • Bundle defines a lottery
  • Expected lottery Average payment
  • Examples
  • Risk aversion
  • better than

6
Utility
  • Uncertainty special preferences
  • Von Neumann-Morgenstern
  • is a Bernoulli utility function
  • Expected Utility

7
Examples (Risk attitudes)
  • Example 1
  • Example 2
  • Example 3

8
Utility and Risk Aversion
9
Utility and Risk Aversion
10
Utility and Risk Aversion
11
Uncertainty (three functions)
12
Certainty Equivalent
  • Certainty equivalent of lottery
  • Example
  • Example
  • Risk Aversion

13
Choice of Insurance
14
Fair Insurance
  • Fair Insurance, why?
  • Expected profit
  • Free Entry and Law of Large Numbers

15
Insurance
  • Bernoulli utility,
  • In optimum (First secret of happiness)

16
Insurance
17
Not Fair Insurance
  • When Insurance is not fair
  • In optimum (First secret of happiness)
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