Chapter twelve Uncertainty
Chapter Twelve Uncertainty
Main issue A state-contingent consumption plan Preferences Under Uncertainty and Expected utility Risk-aversion risk-loving and risk neutrality Competitive Insurance
Main Issue A state-contingent consumption plan Preferences Under Uncertainty and Expected utility Risk-aversion, risk-loving, and riskneutrality Competitive Insurance
Uncertainty is Pervasive What is uncertain in economic systems? tomorrow's prices future wealth future availability of commodities present and future actions of other people
Uncertainty is Pervasive What is uncertain in economic systems? – tomorrow’s prices – future wealth – future availability of commodities –present and future actions of other people
Uncertainty is Pervasive What are rational responses to uncertainty? buying insurance(health, life, auto a portfolio of contingent consumption goods
Uncertainty is Pervasive What are rational responses to uncertainty? –buying insurance (health, life, auto) – a portfolio of contingent consumption goods
States of Nature Possible states of nature: car accident(a) “ no car accident(na) Accident occurs with probability n does not with probability Tna j a na Accident causes a loss of sl
States of Nature Possible states of Nature: – “car accident” (a) – “no car accident” (na). Accident occurs with probability a , does not with probability na ; a + na = 1. Accident causes a loss of $L
Contingencies A contract implemented only when a particular state of Nature occurs is state-contingent E.g. the insurer pays only if there is an accident
Contingencies A contract implemented only when a particular state of Nature occurs is state-contingent. E.g. the insurer pays only if there is an accident
Contingencies A state-contingent consumption plan is implemented only when a particular state of Nature occurs E.g. take a vacation only if there is no accident
Contingencies A state-contingent consumption plan is implemented only when a particular state of Nature occurs. E.g. take a vacation only if there is no accident
State-Contingent Budget Constraints Each $1 of accident insurance costs y Consumer has sm of wealth. Cna is consumption value in the no accident state c is consumption value in the accident state
State-Contingent Budget Constraints Each $1 of accident insurance costs . Consumer has $m of wealth. Cna is consumption value in the noaccident state. Ca is consumption value in the accident state
State-Contingent Budget Constraints
State-Contingent Budget Constraints Cna Ca
State-Contingent Budget Constraints A state-contingent consumption with $17 consumption value in the 20 accident state and $20 consumption value in the no-accident state 17
State-Contingent Budget Constraints Cna Ca 20 17 A state-contingent consumption with $17 consumption value in the accident state and $20 consumption value in the no-accident state