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L11

L11. Buying and Selling: Uncertainty. 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). Uncertainty.

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L11

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  1. L11 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 value: “Average payment” • Examples • Risk aversion better than

  6. Utility • Uncertainty – special preferences • Von Neumann-Morgenstern is a Bernoulli utility function • Expected Utility • Useful property:

  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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