Uncertainty and Consumer Behavior

1
Uncertainty and Consumer Behavior

• Riiiisk.

2
Uncertainty and Risk

• Risk is associated to uncertain events.
• Uncertainty refers to unknown outcomes of
  stochastic variables i.e. dices throw.
• Two cases
• Dices known distribution
• Unknown distributions what the future brings?

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A Game

• 1, 2, 3, 4 ? s (shine)
• 5, 6 ? r (rain)
• Three dices ? three days
• Options
• sss ssr srr rrr
• Probabilities
• P(s) 2/3
• P(r) 1/3

4
A Game

• You are given 10 units of money
• You have to gamble 2 units each time (5 times)
• Your betting options
• If the outcome doesnt fit with your bet, you
  give back the money

At least 1s At least 2s At least 2r 3r
-75 -50 -25 -0
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Distribution Probability
At least 1s P(3s) P(2s) P(1s)
At least 2s P(3s) P(2s)
At least 2r P(2r) P(3r)
3r P(3r)
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Example
Your choice ? At least 1s At least 2s At least 2r 3r Actual Outcome
Your choice ?
First Round
Second Round
Third Round
Fourth Round
Fifth Round
Payoff Final Payoff
-2
-0,25
-0,25
-2
-2
-6,50
3,50
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Theory of Probability

• P(3s) 2/32/32/3 8/27
• P(3s) 8/27 0,296
• P(2s and r) 32/32/31/3 12/27
• P(2s and r) 12/27 0,444
• P(s and 2r) 32/31/31/3 6/27
• P(s and 2r) 6/27 0,222
• P(3r) 1/31/31/3 1/27
• P(3r) 1/27 0,037

• P(3s) ?
• P(s) 2/3
• P(3s) P(s) P(s) P(s)
• P(2s and r)?
• P(s) 2/3
• P(r) 1/3
• ssr srs rss ?
• P(2s and r) 3P(s)P(s)P(r)
• P(s and 2r)?
• P(s and 2r) 3P(s)P(r)P(r)
• P(3r) ?
• P(3r) P(r)P(r)P(r)

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The Expected Value of the Distribution
ltxgt 0p(3s) 1p(2s and r) 2p(s and 2r)
3p(3r)
ltxgt 00,296 10,444 20,222 30,037
1,00
ltxgt np(r) 31/3
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The Variance of the Distribution
?2ltxgt (0 -1)2 P(3s) (1-1)2 P(2s and r) (2
-1)2 P(s and 2r) (3 -1)2 P(3r)
?2ltxgt 10,29 00,44 10,22 220,037
?2ltxgt 0,29 0,22 40,037
?2ltxgt 0,658
?2ltxgt nP(s)P(r)
?2ltxgt 32/31/3
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Preferences toward Risk(Risk Aversion)
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Preferences toward Risk(Risk Loving)
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Risk Aversion and Indifference Curves
U2
U1
U2
U0
U1
U0
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Measures for Risk Attitudes

• Absolute Risk Aversion

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Measures for Risk Attitudes

• Relative Risk Aversion

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Risk Coping Strategies

• Diversification
• Dont put all your eggs in one basket
• Insurance
• Information