ECO200Y1 Lecture Notes - Lecture 11: Utility, Risk Neutral, National Post

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30 Nov 2017
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ECO200Y1 Full Course Notes
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ECO200Y1 Full Course Notes
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Source: bb, chapter 15, sections 15. 2, 15. 4 (parts) and lecture. We now explicitly distinguish between monetary values (dollars won or lost) and the utility associated with levels of wealth (higher if a winner, lower if a loser). The price to play the game is . (you of course have precisely in your pocket to play the game; this is your entire wealth!). Let"s now introduce a utility function, as follows: u = u(w). This is a cardinal utility function2 that describes how you assess, in satisfaction terms, different levels of money wealth (w). Now that there is an evaluation of different levels of wealth, let"s return to the question of whether you will play the game. Recall you have an endowment of (your only wealth). Final position is sh; if you win, your final position is . If you do not play, your position remains at . Suppose your utility function is u = u(w) = w1/2 .

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