How do we cope with uncertainty?
|
|
- Clarence Fisher
- 5 years ago
- Views:
Transcription
1 Topic 3: Choice under uncertainty (K&R Ch. 6) In 1965, a Frenchman named Raffray thought that he had found a great deal: He would pay a 90-year-old woman $500 a month until she died, then move into her grand apartment...but Raffray died at the age 77, having flocked over $184,000 for an apartment he never got to live in... This reminds us that life is full of uncertainty Agents face uncertainty both as demanders of goods but also as suppliers of inputs When buy car, it might be a lemon! (bad quality) When you supply labour you may suffer serious accident while on the job. But outcomes are not always bad: You might win the lotto (it could be you!), You invested in housing and the market exceeded your expectations. The bottom line is that consumers make decisions without knowing for certain what the consequences will be! In this topic we use the basic tools we have learned so far to study choice under uncertainty! 1 2 How do we cope with uncertainty? To study uncertainty we look at an individual s decision whether or not to accept a gamble. Suppose M= and offered a gamble For each 1 you bet you lose 1 if a heart is drawn but receive 40p if club, spade or diamond. How much do you bet? To answer this we use the procedure developed so far. But need to say something on what goods/commodities you are choosing when deciding how much to bet. But with one difference now we have contingent commodities and states of the world. consumption 140 if a not heart slope: e -1 1 endowment: no gambling? 3 states of the world 99 consumption if a heart 4 Probability and expected value What about the likelihood that different states of the world occur? This likelihood is measured by probability (if event cannot occur the probability is zero; if it occurs with certainty the probability is 1). Probability of a heart drawn from a fair deck of cards is 13/52=1/4. Probability of not a heart is drawn is ¾. For a given random process the probabilities of all the states of the world must sum up to 1. What is then the expected winnings of previous gamble? ¾ *.40 + ¼ * (-1) =.05 ; this is the expected value of the gamble (what you expect on average to happen). Suppose now that the gamble is as follows: if a heart appears you win a 1 if not then you lose 0.33, what is the expected value of the gamble? ¼ * 1 ¾ * 0.33 = =0 a gamble with 0 expected monetary gain is called actuarially fair (on average you win or lose nothing) but what is the slope of the budget constrain associated with this bet? it is simply ρ * W + (1 ρ)* L = 0 L ρ = W 1 ρ 5 6 1
2 a not heart Example: Bet 20, with fair odds (win 20 with prob. ¼, lose 20/3 with prob. ¾) e ¼*(+20)+¾*(-20/3) =1200/12=. odds: the ratio of probabilities of two events ρ * W + (1 ρ)* L = 0 L ρ = W 1 ρ fair odds line: The expected value of consumption is equal at every bundle on fair odds line a heart 7 Just as individuals have preferences between different goods, they have preferences between consumption in different states of the world (i.e., different combinations of contingent commodities). The normal assumptions still apply here but we need one additional: the marginal utility of consumption is independent of the state of the world. Preferences between contingent commodities reflect an individual s attitude towards risk. 8 Risk averse consumers are those who do not like risk. They always prefer a sure thing and will not accept an actuarially fair gamble (this is the definition). Risk lovers prefer uncertainty so they prefer a gamble to a sure thing. Risk neutral people are indifferent among all alternatives with the same expected value. Preferences (risk loving) other Now we need to rank the various alternatives. You care about the amount of consumption in both states of the world certainty line connects all possible endowment points (it is the locus of all possible certain consumption levels slope ρ * W + (1 ρ)* L = 0 L ρ = W 1 ρ fair odds line 9 heart 10 Preferences (risk neutral) Preferences (risk averse) other certainty line other certainty line fair odds line= indifference curve fair odds line heart 11 heart 12 2
3 Equilibrium Equilibrium for a risk averse (how much does she bet?) Equilibrium occurs where the highest indifference curve possible is reached on the budget constraint. Will a risk averse consumer accept an actuarially fair gamble? No! Why? Because ends up with same level of wealth (equal to her endowment!) without facing the uncertainty of the gamble! other a bet e though on average there is a gain she does not bet a lot of money budget constraint 13 heart 14 Equilibrium for a risk lover (how much does she bet?) heads a e though on average there is a loss she bets all of her income (corner solution) Which type of preference is more relevant for understanding behaviour? There is strong evidence that for the important decisions most people are risk averse (most people buy insurance at a high price). Lotteries (and casinos!) suggest that many people are risk lovers for small bets. tails Risk premia Risk premium: extra return on an investment to compensate for risk. Example. return in bad state certainty line e b return in good state 18 3
4 Should we keep all eggs in one basket? Diversification: the process of buying several assets in order to reduce risk. Example: 2 assets, both same expected return, but (perfectly) negatively correlated. Then split investment! (Diversify). Application: Tax evasion Tax evasion: the failure to pay taxes that are legally due. Optimal policy? If risk averse penalty should be such that she faces an actuarially fair gamble. The higher the tax the higher should the penalty be! (See example) Example Consider Elena who is risk averse and amoral citizen. Her before tax income is 1,500. She faces a tax system t=1/3 (if declares 1,500 then net income is 1,500(1- t)= 1,000. If she decides to evade taxes and caught then is is fined f=0.8 for every evaded. not (1-r) 1,500 C.na 1,000 b e certainty line 21 1,000-C.a=taxes not paid C.a 1, audited (r) 22 Optimal policy Recall that Elena is risk averse. What it then the optimal policy (i.e, policy that reduces tax evasion). (1 r) t rf = 0 f * 1 r = t r Equation says: The penalty rate should be set so that it at least equals the odds of not being audited time the tax rate. Suppose r=0.1 then (1-r)/r=9 so a high penalty is required (9*t=3 for each evaded the evader should be fined 3.) Also the higher the tax, t, the higher the fine, f. Why?
5 Insurance Previously we asked whether consumers would like to gamble. Typically consumers have no choice (life is uncertain). Fair insurance Premium: the price of obtaining insurance coverage. Actuarially fair insurance: the premium paid is equal to the expected payout of the insurance provider. Example: Scarlet is obstetrician facing probability p of being sued and losing. She wants to buy insurance with premium k Preferences (full insurance) Actuarially fair is when p=k. endowment C-ns a slope: -p/(1-p) if sued the she has 0 income C-ns a insurance expenditure C*ns sl: -p/1-p in the sense that C*s=C*ns b b C-s 27 C*s C-s 28 Demand for unfair insurance Equilibrium with actuarially unfair insurance If the premium equals expected benefit then firms make no profits (possibly negative if consider labour costs, i.e., operating costs). So typically insurance policies are unfair (expected payments are less than premium paid---on average). Think of two different people (that belong two different risk classes) but yet pay more or less on same risk premia. 29 C-ns 45 certainty line C-s 30 5
6 When the insurance policy is actuarially unfair even a risk-averse individual purchases less than full insurance. Intuition: When the premium is higher than the expected payoff it is rational to assume some risk in return for reducing the payments to the insurance. Decision making with many uncertain outcomes: Von Neumann-Morgenstern utility So far the focus was on only two possible outcomes. But in many realistic situations there are more than two possible outcomes. We now introduce decision trees A decision tree Utility functions for uncertain outcomes decision node economics pass fail pass ,000 3,000 7,000 U c, c, c,..., c ; ρ, ρ, ρ,..., ρ ) = ρ u( c ) ρ u( c ) ( n n 1 1 n n Von Neumann-Morgenstern utility function: A utility function where the utility associated with some uncertain event is the expected value of the utilities of each of the possible outcomes politics fail 0.6 2,000 Now, what about sequential decisions? Asymmetric Information In markets buyers and sellers have different information Example 1: Seller and buyer of second hand car; seller knows quality but buyer does not (car may be lemon or plum ). Example 2: Labour markets: Employees know ability of themselves but employer does not. Example 3: Incumbents know ability but voters do not. Information about quality, ability may be costly to obtain (sometimes impossible: may be impossible or costly for a firm to determine how productive employees are). All these problems of asymmetric information may cause problems with the efficient functioning of a market. Terminology: Hidden action: action taken by a party not observed (but affected) by another
7 Adverse selection: Selection of inappropriate outcomes due to asymmetric information (e.g car market). Moral hazard: inappropriately taken actions (e.g insurance). (Aside: Akerlof, Spence and Stiglitz Nobel Prize winners in economics for their work on asymmetric information). The market for Lemons (interesting example) people want to sell their second hand cars. people want to buy a second hand car. Everyone knows that 50 are lemons and 50 are plums. Asymmetric information: owner knows quality but buyers does not. The owner of a lemon wants 1, The owner of a plum wants 2,000. The buyers are willing to pay 2,400 for a plum and 1,200 for a lemon. If information is perfect then market works Problems arises when quality is not observable. Assume that, when quality is not observed a buyers is willing to pay the expected quality of a second hand car 1 1 1,200+ 2,400 = 1, In this case no plum will be sold only lemons! Why? Because the owners of plums would not sell because the price offered by the buyers is below their reservation price. Only sellers of lemons would be in the market Quality choice Variation of previous idea quality now is determined by producers Suppose consumers buy umbrellas (U) for high quality they are willing to pay 14 and for low 8 (and is impossible to tell quality without trying Us) Suppose that cost of of both qualities of U is What is the equilibrium quality of Us? Consumers are uncertain about quality so expect average quality sold p = 14q + 8(1 q) 3 cases to consider 1. Only low quality Us will be produced 2. Only high quality Us will be produced 3. Both qualities will be produced
8 Case 1: Consumer will only pay low-quality price (but because it costs no Us will be produced) Case 2: Consumers are willing to pay 14 but price is (so consumer surplus is 2.50) Case 3: Competition makes sure that price is Average quality must have a value (for consumers to buy) of at lease the cost of Us that is, 14q + 8(1 q) Equilibrium Price, p q + 8(1 q) q=1 Demand Many equilibria!! Supply 7/12 Fraction of high quality Us, q Adverse selection Example described adverse selection problem (low quality crowd out high quality products). Why? Because information is costly to acquire. Another example: Insurance Insurance company wants to design an insurance scheme for bicycles based on average theft rate. What will happen? Insurance company will go bankrupt! Why? Only high risk consumers would buy insurance! (they are the ones who need it!)--adverse selection again! It then follows that insurance should base scheme on risky customers. Similar problem with health insurance Moral hazard Moral hazard arises when probability of event is affected by the action taken: Example: insurance of bicycle but also health insurance. If consumer is completely insured against the bad outcome then the incentive to take appropriate care is missing: This lack of incentive is called moral hazard. Problem arise because effort is unobservable! Moral hazard and adverse selection Moral hazard refers to situations where one side of the market cannot observe actions of the other (also called hidden action). Adverse selection refers to situations where one side of the market cannot observe the type or quality of the goods on other side of market (also called hidden information)
9 Equilibrium characterisation Equilibrium in a market involving hidden actions is characterised by some form of rationing. Equilibrium in a market involving hidden information is characterised by too little trade (due to negative externalities the bad quality imposes on good quality good). Equilibrium in both instances is inefficient. Signalling In car market example asymmetric information caused problems But the owners of good cars have incentive to signal the quality of car to potential buyers (warranty!) Signalling makes market perform better Spence s model of education 2 types of workers, able and unable. The able has marginal product a and the unable b, with a>b. In total there are L able and K unable workers. Output is al+bk. If ability was known the firm would offer wage equal to marginal productivity of types. But ability is not observable so firm offers expected wage w=la+kb. Workers (in particular the able ones) have incentive to distinguish themselves from the unable ones. How? By choosing some level of education not attainable by the unable ones Equilibria In this example there are 2 possible (for this course) equilibria. Pooling: meaning that both types choose the same level of education. This is an equilibrium in which able and unable workers pool on the same policy. In this case firm cannot distinguish type and therefore offers expected wage. Separating: Both types have an incentive to choose a level of education such that the types of workers are revealed. In this equilibrium firm knows types and sets wages according to marginal productivity of workers. Both equilibria have interesting features The separating is inefficient from a social point of view. Able workers invest in signals that confer no social benefit (only private)
10 In the pooling the wage set, in the presence of unable workers, is depressed (externality), giving the able workers the incentive to invest in costly signals In general signalling is not bad since, as in example with types of cars, it facilitates trade. END OF TOPIC
UNCERTAINTY AND INFORMATION
UNCERTAINTY AND INFORMATION M. En C. Eduardo Bustos Farías 1 Objectives After studying this chapter, you will be able to: Explain how people make decisions when they are uncertain about the consequences
More informationDARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 21. Dartmouth College, Department of Economics: Economics 21, Summer 02. Topic 5: Information
Dartmouth College, Department of Economics: Economics 21, Summer 02 Topic 5: Information Economics 21, Summer 2002 Andreas Bentz Dartmouth College, Department of Economics: Economics 21, Summer 02 Introduction
More informationInsurance, Adverse Selection and Moral Hazard
University of California, Berkeley Spring 2007 ECON 100A Section 115, 116 Insurance, Adverse Selection and Moral Hazard I. Risk Premium Risk Premium is the amount of money an individual is willing to pay
More informationEco 300 Intermediate Micro
Eco 300 Intermediate Micro Instructor: Amalia Jerison Office Hours: T 12:00-1:00, Th 12:00-1:00, and by appointment BA 127A, aj4575@albany.edu A. Jerison (BA 127A) Eco 300 Spring 2010 1 / 32 Applications
More informationChapter 9 THE ECONOMICS OF INFORMATION. Copyright 2005 by South-Western, a division of Thomson Learning. All rights reserved.
Chapter 9 THE ECONOMICS OF INFORMATION Copyright 2005 by South-Western, a division of Thomson Learning. All rights reserved. 1 Properties of Information Information is not easy to define it is difficult
More informationPrice Theory Lecture 9: Choice Under Uncertainty
I. Probability and Expected Value Price Theory Lecture 9: Choice Under Uncertainty In all that we have done so far, we've assumed that choices are being made under conditions of certainty -- prices are
More informationPindyck and Rubinfeld, Chapter 17 Sections 17.1 and 17.2 Asymmetric information can cause a competitive equilibrium allocation to be inefficient.
Pindyck and Rubinfeld, Chapter 17 Sections 17.1 and 17.2 Asymmetric information can cause a competitive equilibrium allocation to be inefficient. A market has asymmetric information when some agents know
More informationLecture 18 - Information, Adverse Selection, and Insurance Markets
Lecture 18 - Information, Adverse Selection, and Insurance Markets 14.03 Spring 2003 1 Lecture 18 - Information, Adverse Selection, and Insurance Markets 1.1 Introduction Risk is costly to bear (in utility
More informationUnit 4.3: Uncertainty
Unit 4.: Uncertainty Michael Malcolm June 8, 20 Up until now, we have been considering consumer choice problems where the consumer chooses over outcomes that are known. However, many choices in economics
More informationChapter 23: Choice under Risk
Chapter 23: Choice under Risk 23.1: Introduction We consider in this chapter optimal behaviour in conditions of risk. By this we mean that, when the individual takes a decision, he or she does not know
More informationMicroeconomics of Banking: Lecture 2
Microeconomics of Banking: Lecture 2 Prof. Ronaldo CARPIO September 25, 2015 A Brief Look at General Equilibrium Asset Pricing Last week, we saw a general equilibrium model in which banks were irrelevant.
More informationUncertainty. Contingent consumption Subjective probability. Utility functions. BEE2017 Microeconomics
Uncertainty BEE217 Microeconomics Uncertainty: The share prices of Amazon and the difficulty of investment decisions Contingent consumption 1. What consumption or wealth will you get in each possible outcome
More information4 Rothschild-Stiglitz insurance market
4 Rothschild-Stiglitz insurance market Firms simultaneously offer contracts in final wealth, ( 1 2 ), space. state 1 - no accident, and state 2 - accident Premiumpaidinallstates, 1 claim (payment from
More informationMicroeconomics (Uncertainty & Behavioural Economics, Ch 05)
Microeconomics (Uncertainty & Behavioural Economics, Ch 05) Lecture 23 Apr 10, 2017 Uncertainty and Consumer Behavior To examine the ways that people can compare and choose among risky alternatives, we
More informationUniversity of California, Davis Department of Economics Giacomo Bonanno. Economics 103: Economics of uncertainty and information PRACTICE PROBLEMS
University of California, Davis Department of Economics Giacomo Bonanno Economics 03: Economics of uncertainty and information PRACTICE PROBLEMS oooooooooooooooo Problem :.. Expected value Problem :..
More informationChapter 18: Risky Choice and Risk
Chapter 18: Risky Choice and Risk Risky Choice Probability States of Nature Expected Utility Function Interval Measure Violations Risk Preference State Dependent Utility Risk-Aversion Coefficient Actuarially
More informationProf. Bryan Caplan Econ 812
Prof. Bryan Caplan bcaplan@gmu.edu http://www.bcaplan.com Econ 812 Week 9: Asymmetric Information I. Moral Hazard A. In the real world, everyone is not equally in the dark. In every situation, some people
More informationExpected value is basically the average payoff from some sort of lottery, gamble or other situation with a randomly determined outcome.
Economics 352: Intermediate Microeconomics Notes and Sample Questions Chapter 18: Uncertainty and Risk Aversion Expected Value The chapter starts out by explaining what expected value is and how to calculate
More information5/2/2016. Intermediate Microeconomics W3211. Lecture 24: Uncertainty and Information 2. Today. The Story So Far. Preferences and Expected Utility
5//6 Intermediate Microeconomics W3 Lecture 4: Uncertainty and Information Introduction Columbia University, Spring 6 Mark Dean: mark.dean@columbia.edu The Story So Far. 3 Today 4 Last lecture we started
More informationConsumer s behavior under uncertainty
Consumer s behavior under uncertainty Microéconomie, Chap 5 1 Plan of the talk What is a risk? Preferences under uncertainty Demand of risky assets Reducing risks 2 Introduction How does the consumer choose
More informationManagerial Economics
Managerial Economics Unit 9: Risk Analysis Rudolf Winter-Ebmer Johannes Kepler University Linz Winter Term 2015 Managerial Economics: Unit 9 - Risk Analysis 1 / 49 Objectives Explain how managers should
More information05/05/2011. Degree of Risk. Degree of Risk. BUSA 4800/4810 May 5, Uncertainty
BUSA 4800/4810 May 5, 2011 Uncertainty We must believe in luck. For how else can we explain the success of those we don t like? Jean Cocteau Degree of Risk We incorporate risk and uncertainty into our
More informationIntroduction to Economics I: Consumer Theory
Introduction to Economics I: Consumer Theory Leslie Reinhorn Durham University Business School October 2014 What is Economics? Typical De nitions: "Economics is the social science that deals with the production,
More informationAsymmetric Information
Asymmetric Information 16 Introduction 16 Chapter Outline 16.1 The Lemons Problem and Adverse Selection 16.2 Moral Hazard 16.3 Asymmetric Information in Principal Agent Relationships 16.4 Signaling to
More informationEconomics Homework 5 Fall 2006 Dickert-Conlin / Conlin
Economics 31 - Homework 5 Fall 26 Dickert-Conlin / Conlin Answer Key 1. Suppose Cush Bring-it-Home Cash has a utility function of U = M 2, where M is her income. Suppose Cush s income is $8 and she is
More informationMarket Failure: Asymmetric Information
Market Failure: Asymmetric Information Ram Singh Microeconomic Theory Lecture 22 Ram Singh: (DSE) Asymmetric Information Lecture 22 1 / 14 Information and Market Transactions Examples Individuals buy and
More informationProject Risk Analysis and Management Exercises (Part II, Chapters 6, 7)
Project Risk Analysis and Management Exercises (Part II, Chapters 6, 7) Chapter II.6 Exercise 1 For the decision tree in Figure 1, assume Chance Events E and F are independent. a) Draw the appropriate
More informationDynamic games with incomplete information
Dynamic games with incomplete information Perfect Bayesian Equilibrium (PBE) We have now covered static and dynamic games of complete information and static games of incomplete information. The next step
More informationCASE FAIR OSTER PRINCIPLES OF MICROECONOMICS E L E V E N T H E D I T I O N. PEARSON 2012 Pearson Education, Inc. Publishing as Prentice Hall
PART II The Market System: Choices Made by Households and Firms PRINCIPLES OF MICROECONOMICS E L E V E N T H E D I T I O N CASE FAIR OSTER PEARSON 2012 Pearson Education, Inc. Publishing as Prentice Hall
More informationUncertainty. The St. Petersburg Paradox. Managerial Economics MBACatólica
Fernando Branco 2006-2007 Fall Quarter Session 9 Part II Uncertainty Most managerial decisions are taken under uncertainty. Some markets trade on the basis of uncertainty (e.g., insurance, stock market).
More informationMock Examination 2010
[EC7086] Mock Examination 2010 No. of Pages: [7] No. of Questions: [6] Subject [Economics] Title of Paper [EC7086: Microeconomic Theory] Time Allowed [Two (2) hours] Instructions to candidates Please answer
More informationLecture - Adverse Selection, Risk Aversion and Insurance Markets
Lecture - Adverse Selection, Risk Aversion and Insurance Markets David Autor 14.03 Fall 2004 1 Adverse Selection, Risk Aversion and Insurance Markets Risk is costly to bear (in utility terms). If we can
More informationEXAMPLE OF FAILURE OF EQUILIBRIUM Akerlof's market for lemons (P-R pp )
ECO 300 Fall 2005 December 1 ASYMMETRIC INFORMATION PART 2 ADVERSE SELECTION EXAMPLE OF FAILURE OF EQUILIBRIUM Akerlof's market for lemons (P-R pp. 614-6) Private used car market Car may be worth anywhere
More informationModels and Decision with Financial Applications UNIT 1: Elements of Decision under Uncertainty
Models and Decision with Financial Applications UNIT 1: Elements of Decision under Uncertainty We always need to make a decision (or select from among actions, options or moves) even when there exists
More informationLecture 10 Game Plan. Hidden actions, moral hazard, and incentives. Hidden traits, adverse selection, and signaling/screening
Lecture 10 Game Plan Hidden actions, moral hazard, and incentives Hidden traits, adverse selection, and signaling/screening 1 Hidden Information A little knowledge is a dangerous thing. So is a lot. -
More informationLecture 12: Introduction to reasoning under uncertainty. Actions and Consequences
Lecture 12: Introduction to reasoning under uncertainty Preferences Utility functions Maximizing expected utility Value of information Bandit problems and the exploration-exploitation trade-off COMP-424,
More informationProblem Set 2. Theory of Banking - Academic Year Maria Bachelet March 2, 2017
Problem Set Theory of Banking - Academic Year 06-7 Maria Bachelet maria.jua.bachelet@gmai.com March, 07 Exercise Consider an agency relationship in which the principal contracts the agent, whose effort
More information5. Uncertainty and Consumer Behavior
5. Uncertainty and Consumer Behavior Literature: Pindyck und Rubinfeld, Chapter 5 16.05.2017 Prof. Dr. Kerstin Schneider Chair of Public Economics and Business Taxation Microeconomics Chapter 5 Slide 1
More informationPractice Problems. U(w, e) = p w e 2,
Practice Problems Information Economics (Ec 515) George Georgiadis Problem 1. Static Moral Hazard Consider an agency relationship in which the principal contracts with the agent. The monetary result of
More informationEconomics 101A (Lecture 25) Stefano DellaVigna
Economics 101A (Lecture 25) Stefano DellaVigna April 29, 2014 Outline 1. Hidden Action (Moral Hazard) II 2. The Takeover Game 3. Hidden Type (Adverse Selection) 4. Evidence of Hidden Type and Hidden Action
More informationPh.D. Preliminary Examination MICROECONOMIC THEORY Applied Economics Graduate Program August 2017
Ph.D. Preliminary Examination MICROECONOMIC THEORY Applied Economics Graduate Program August 2017 The time limit for this exam is four hours. The exam has four sections. Each section includes two questions.
More informationFinal Solutions ECON 301 May 13, 2012
Final Solutions ECON May, Problem a) Because it is easier and more familiar, we will work with the monotonic transformation (and thus equivalent) utility function: U(x, x ) = log x + log x. MRS = MUx MU
More informationDecision Analysis under Uncertainty. Christopher Grigoriou Executive MBA/HEC Lausanne
Decision Analysis under Uncertainty Christopher Grigoriou Executive MBA/HEC Lausanne 2007-2008 2008 Introduction Examples of decision making under uncertainty in the business world; => Trade-off between
More informationECONOMICS OF UNCERTAINTY AND INFORMATION
ECONOMICS OF UNCERTAINTY AND INFORMATION http://greenplanet.eolss.net/eolsslogn/searchdt_advanced/searchdt_cate... 1 of 7 11/19/2011 5:15 PM Search Print this chapter Cite this chapter ECONOMICS OF UNCERTAINTY
More informationChoice under risk and uncertainty
Choice under risk and uncertainty Introduction Up until now, we have thought of the objects that our decision makers are choosing as being physical items However, we can also think of cases where the outcomes
More informationLecture 13: Asymmetric information
Lecture 13: Asymmetric information EC 105. Industrial Organization. Matt Shum HSS, California Institute of Technology EC 105. Industrial Organization. (Matt Shum HSS, California Institute Lecture of 13:
More informationChoice Under Uncertainty (Chapter 12)
Choice Under Uncertainty (Chapter 12) January 6, 2011 Teaching Assistants Updated: Name Email OH Greg Leo gleo[at]umail TR 2-3, PHELP 1420 Dan Saunders saunders[at]econ R 9-11, HSSB 1237 Rish Singhania
More informationThe Economics of Public Policy 7. Market Failures due to Asymmetric Information
Fletcher School of Law and Diplomacy, Tufts University The Economics of Public Policy 7. Market Failures due to Asymmetric Information Prof George Alogoskoufis The US Constitution, the Role of Government
More informationMICROECONOMIC THEROY CONSUMER THEORY
LECTURE 5 MICROECONOMIC THEROY CONSUMER THEORY Choice under Uncertainty (MWG chapter 6, sections A-C, and Cowell chapter 8) Lecturer: Andreas Papandreou 1 Introduction p Contents n Expected utility theory
More informationEconomics 101A (Lecture 26) Stefano DellaVigna
Economics 101A (Lecture 26) Stefano DellaVigna April 27, 2017 Outline 1. Hidden Action (Moral Hazard) II 2. Hidden Type (Adverse Selection) 3. Empirical Economics: Intro 4. Empirical Economics: Retirement
More informationSequential-move games with Nature s moves.
Econ 221 Fall, 2018 Li, Hao UBC CHAPTER 3. GAMES WITH SEQUENTIAL MOVES Game trees. Sequential-move games with finite number of decision notes. Sequential-move games with Nature s moves. 1 Strategies in
More informationFinal Examination December 14, Economics 5010 AF3.0 : Applied Microeconomics. time=2.5 hours
YORK UNIVERSITY Faculty of Graduate Studies Final Examination December 14, 2010 Economics 5010 AF3.0 : Applied Microeconomics S. Bucovetsky time=2.5 hours Do any 6 of the following 10 questions. All count
More informationMicroeconomics II. CIDE, MsC Economics. List of Problems
Microeconomics II CIDE, MsC Economics List of Problems 1. There are three people, Amy (A), Bart (B) and Chris (C): A and B have hats. These three people are arranged in a room so that B can see everything
More informationFinancial markets in developing countries (rough notes, use only as guidance; more details provided in lecture) The role of the financial system
Financial markets in developing countries (rough notes, use only as guidance; more details provided in lecture) The role of the financial system matching savers and investors (otherwise each person needs
More informationASHORTCOURSEIN INTERMEDIATE MICROECONOMICS WITH CALCULUS. allan
ASHORTCOURSEIN INTERMEDIATE MICROECONOMICS WITH CALCULUS Roberto Serrano 1 and Allan M. Feldman 2 email: allan feldman@brown.edu c 2010, 2011 Roberto Serrano and Allan M. Feldman All rights reserved 1
More informationManagerial Economics Uncertainty
Managerial Economics Uncertainty Aalto University School of Science Department of Industrial Engineering and Management January 10 26, 2017 Dr. Arto Kovanen, Ph.D. Visiting Lecturer Uncertainty general
More information12.2 Utility Functions and Probabilities
220 UNCERTAINTY (Ch. 12) only a small part of the risk. The money backing up the insurance is paid in advance, so there is no default risk to the insured. From the economist's point of view, "cat bonds"
More informationU(x 1, x 2 ) = 2 ln x 1 + x 2
Solutions to Spring 014 ECON 301 Final Group A Problem 1. (Quasilinear income effect) (5 points) Mirabella consumes chocolate candy bars x 1 and fruits x. The prices of the two goods are = 4 and p = 4
More informationCHOICE THEORY, UTILITY FUNCTIONS AND RISK AVERSION
CHOICE THEORY, UTILITY FUNCTIONS AND RISK AVERSION Szabolcs Sebestyén szabolcs.sebestyen@iscte.pt Master in Finance INVESTMENTS Sebestyén (ISCTE-IUL) Choice Theory Investments 1 / 65 Outline 1 An Introduction
More informationUC Berkeley Haas School of Business Economic Analysis for Business Decisions (EWMBA 201A) Fall Module I
UC Berkeley Haas School of Business Economic Analysis for Business Decisions (EWMBA 201A) Fall 2018 Module I The consumers Decision making under certainty (PR 3.1-3.4) Decision making under uncertainty
More informationECO 317 Economics of Uncertainty Fall Term 2009 Notes for lectures 9. Demand for Insurance
The Basic Two-State Model ECO 317 Economics of Uncertainty Fall Term 2009 Notes for lectures 9. Demand for Insurance Insurance is a method for reducing (or in ideal circumstances even eliminating) individual
More informationMicroeconomics of Banking: Lecture 3
Microeconomics of Banking: Lecture 3 Prof. Ronaldo CARPIO Oct. 9, 2015 Review of Last Week Consumer choice problem General equilibrium Contingent claims Risk aversion The optimal choice, x = (X, Y ), is
More informationBanking, Liquidity Transformation, and Bank Runs
Banking, Liquidity Transformation, and Bank Runs ECON 30020: Intermediate Macroeconomics Prof. Eric Sims University of Notre Dame Spring 2018 1 / 30 Readings GLS Ch. 28 GLS Ch. 30 (don t worry about model
More informationAS/ECON 4070 AF Answers to Assignment 1 October 2001
AS/ECON 4070 AF Answers to Assignment 1 October 2001 1. Yes, the allocation will be efficient, since the tax in this question is a tax on the value of people s endowments. This is a lump sum tax. In an
More informationDevelopment Economics Part II Lecture 7
Development Economics Part II Lecture 7 Risk and Insurance Theory: How do households cope with large income shocks? What are testable implications of different models? Empirics: Can households insure themselves
More informationRevision Lecture Microeconomics of Banking MSc Finance: Theory of Finance I MSc Economics: Financial Economics I
Revision Lecture Microeconomics of Banking MSc Finance: Theory of Finance I MSc Economics: Financial Economics I April 2005 PREPARING FOR THE EXAM What models do you need to study? All the models we studied
More informationd. Find a competitive equilibrium for this economy. Is the allocation Pareto efficient? Are there any other competitive equilibrium allocations?
Answers to Microeconomics Prelim of August 7, 0. Consider an individual faced with two job choices: she can either accept a position with a fixed annual salary of x > 0 which requires L x units of labor
More informationEconomics Honors Exam Review (Micro) Mar Based on Zhaoning Wang s final review packet for Ec 1010a, Fall 2013
Economics Honors Exam Review (Micro) Mar. 2017 Based on Zhaoning Wang s final review packet for Ec 1010a, Fall 201 1. The inverse demand function for apples is defined by the equation p = 214 5q, where
More informationCHAPTER 29 Job market signaling Market for lemons 1-1
. CHAPTER 29 Job market signaling Market for lemons 1-1 Two applications of PBE A PBE insist on rationality of beliefs as well as of strategies: Definition: Consider a pair (s,b) consisting of a profile
More informationClosed book/notes exam. No computer, calculator, or any electronic device allowed.
Econ 131 Spring 2017 Emmanuel Saez Final May 12th Student Name: Student ID: GSI Name: Exam Instructions Closed book/notes exam. No computer, calculator, or any electronic device allowed. No phones. Turn
More informationChapter 05 Understanding Risk
Chapter 05 Understanding Risk Multiple Choice Questions 1. (p. 93) Which of the following would not be included in a definition of risk? a. Risk is a measure of uncertainty B. Risk can always be avoided
More informationEcon 101A Final Exam We May 9, 2012.
Econ 101A Final Exam We May 9, 2012. You have 3 hours to answer the questions in the final exam. We will collect the exams at 2.30 sharp. Show your work, and good luck! Problem 1. Utility Maximization.
More informationCONTRACT THEORY. Patrick Bolton and Mathias Dewatripont. The MIT Press Cambridge, Massachusetts London, England
r CONTRACT THEORY Patrick Bolton and Mathias Dewatripont The MIT Press Cambridge, Massachusetts London, England Preface xv 1 Introduction 1 1.1 Optimal Employment Contracts without Uncertainty, Hidden
More informationGolden rule. The golden rule allocation is the stationary, feasible allocation that maximizes the utility of the future generations.
The golden rule allocation is the stationary, feasible allocation that maximizes the utility of the future generations. Let the golden rule allocation be denoted by (c gr 1, cgr 2 ). To achieve this allocation,
More informationU(x 1. ; x 2 ) = 4 ln x 1
Econ 30 Intermediate Microeconomics Prof. Marek Weretka Final Exam (Group A) You have h to complete the exam. The nal consists of 6 questions (5+0+0+5+0+0=00). Problem. (Quasilinaer income e ect) Mirabella
More informationIncentives and Information Security
Incentives and Information Security R. Anderson, T. Moore, S. Nagaraja and A. Ozment November 24, 2009 Motivation Many systems fail not ultimately for technical reasons but because incentives are wrong.
More informationNotes 10: Risk and Uncertainty
Economics 335 April 19, 1999 A. Introduction Notes 10: Risk and Uncertainty 1. Basic Types of Uncertainty in Agriculture a. production b. prices 2. Examples of Uncertainty in Agriculture a. crop yields
More informationDepartment of Economics The Ohio State University Final Exam Questions and Answers Econ 8712
Prof. Peck Fall 016 Department of Economics The Ohio State University Final Exam Questions and Answers Econ 871 1. (35 points) The following economy has one consumer, two firms, and four goods. Goods 1
More informationAS/ECON AF Answers to Assignment 1 October Q1. Find the equation of the production possibility curve in the following 2 good, 2 input
AS/ECON 4070 3.0AF Answers to Assignment 1 October 008 economy. Q1. Find the equation of the production possibility curve in the following good, input Food and clothing are both produced using labour and
More informationBasic Tools of Finance (Chapter 27 in Mankiw & Taylor)
Basic Tools of Finance (Chapter 27 in Mankiw & Taylor) We have seen that the financial system coordinates saving and investment These are decisions made today that affect us in the future But the future
More informationEC202. Microeconomic Principles II. Summer 2009 examination. 2008/2009 syllabus
Summer 2009 examination EC202 Microeconomic Principles II 2008/2009 syllabus Instructions to candidates Time allowed: 3 hours. This paper contains nine questions in three sections. Answer question one
More informationCUR 412: Game Theory and its Applications, Lecture 12
CUR 412: Game Theory and its Applications, Lecture 12 Prof. Ronaldo CARPIO May 24, 2016 Announcements Homework #4 is due next week. Review of Last Lecture In extensive games with imperfect information,
More informationDynamic Lending under Adverse Selection and Limited Borrower Commitment: Can it Outperform Group Lending?
Dynamic Lending under Adverse Selection and Limited Borrower Commitment: Can it Outperform Group Lending? Christian Ahlin Michigan State University Brian Waters UCLA Anderson Minn Fed/BREAD, October 2012
More informationLecture 13: Social Insurance
Lecture 13: Social Insurance November 24, 2015 Overview Course Administration Ripped From Headlines Why Should We Care? What is Insurance? Why Social Insurance? Additional Reasons for Government Intervention
More informationProblem Set. Solutions to the problems appear at the end of this document.
Problem Set Solutions to the problems appear at the end of this document. Unless otherwise stated, any coupon payments, cash dividends, or other cash payouts delivered by a security in the following problems
More informationA key characteristic of financial markets is that they are subject to sudden, convulsive changes.
10.6 The Diamond-Dybvig Model A key characteristic of financial markets is that they are subject to sudden, convulsive changes. Such changes happen at both the microeconomic and macroeconomic levels. At
More informationThis assignment is due on Tuesday, September 15, at the beginning of class (or sooner).
Econ 434 Professor Ickes Homework Assignment #1: Answer Sheet Fall 2009 This assignment is due on Tuesday, September 15, at the beginning of class (or sooner). 1. Consider the following returns data for
More informationSCREENING BY THE COMPANY YOU KEEP: JOINT LIABILITY LENDING AND THE PEER SELECTION EFFECT
SCREENING BY THE COMPANY YOU KEEP: JOINT LIABILITY LENDING AND THE PEER SELECTION EFFECT Author: Maitreesh Ghatak Presented by: Kosha Modi February 16, 2017 Introduction In an economic environment where
More information8/28/2017. ECON4260 Behavioral Economics. 2 nd lecture. Expected utility. What is a lottery?
ECON4260 Behavioral Economics 2 nd lecture Cumulative Prospect Theory Expected utility This is a theory for ranking lotteries Can be seen as normative: This is how I wish my preferences looked like Or
More informationPAULI MURTO, ANDREY ZHUKOV
GAME THEORY SOLUTION SET 1 WINTER 018 PAULI MURTO, ANDREY ZHUKOV Introduction For suggested solution to problem 4, last year s suggested solutions by Tsz-Ning Wong were used who I think used suggested
More informationECMC49S Midterm. Instructor: Travis NG Date: Feb 27, 2007 Duration: From 3:05pm to 5:00pm Total Marks: 100
ECMC49S Midterm Instructor: Travis NG Date: Feb 27, 2007 Duration: From 3:05pm to 5:00pm Total Marks: 100 [1] [25 marks] Decision-making under certainty (a) [10 marks] (i) State the Fisher Separation Theorem
More informationMA200.2 Game Theory II, LSE
MA200.2 Game Theory II, LSE Problem Set 1 These questions will go over basic game-theoretic concepts and some applications. homework is due during class on week 4. This [1] In this problem (see Fudenberg-Tirole
More informationGeneral Examination in Microeconomic Theory SPRING 2014
HARVARD UNIVERSITY DEPARTMENT OF ECONOMICS General Examination in Microeconomic Theory SPRING 2014 You have FOUR hours. Answer all questions Those taking the FINAL have THREE hours Part A (Glaeser): 55
More informationGraduate Microeconomics II Lecture 8: Insurance Markets
Graduate Microeconomics II Lecture 8: Insurance Markets Patrick Legros 1 / 31 Outline Introduction 2 / 31 Outline Introduction Contingent Markets 3 / 31 Outline Introduction Contingent Markets Insurance
More informationPh.D. Preliminary Examination MICROECONOMIC THEORY Applied Economics Graduate Program June 2015
Ph.D. Preliminary Examination MICROECONOMIC THEORY Applied Economics Graduate Program June 2015 The time limit for this exam is four hours. The exam has four sections. Each section includes two questions.
More informationLearning Objectives = = where X i is the i t h outcome of a decision, p i is the probability of the i t h
Learning Objectives After reading Chapter 15 and working the problems for Chapter 15 in the textbook and in this Workbook, you should be able to: Distinguish between decision making under uncertainty and
More informationHow Markets Work: Lessons for Workers Compensation
2013 Annual Issues Symposium How Markets Work: Lessons for Workers Compensation Harry Shuford Practice Leader and Chief Economist May 17, 2013 How Markets Work: Lessons for Workers Compensation The Standard
More informationPart 4: Market Failure II - Asymmetric Information Adverse Selection and Signaling
Part 4: Market Failure II - Asymmetric Information Adverse Selection and Signaling Adverse Selection, Lemons Market, Market Breakdown, Costly Signals, Signaling, Separating Equilibrium July 2016 Adverse
More informationName. Final Exam, Economics 210A, December 2014 Answer any 7 of these 8 questions Good luck!
Name Final Exam, Economics 210A, December 2014 Answer any 7 of these 8 questions Good luck! 1) For each of the following statements, state whether it is true or false. If it is true, prove that it is true.
More informationPrinciples of Finance Risk and Return. Instructor: Xiaomeng Lu
Principles of Finance Risk and Return Instructor: Xiaomeng Lu 1 Course Outline Course Introduction Time Value of Money DCF Valuation Security Analysis: Bond, Stock Capital Budgeting (Fundamentals) Portfolio
More information