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Lecture 18

Economics 2150A/B Lecture Notes - Lecture 18: Marginal Utility, Risk Premium, Indifference Curve

4 pages65 viewsWinter 2014

Department
Economics
Course Code
Economics 2150A/B
Professor
Kristin Denniston
Lecture
18

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Economics 2151B
Monday March 12
Lecture 17
Chapter 15 – Uncertainty and Imperfect Information
Homework 4
Due Monday March 24
Chapters 14 and 15
Under ‘Tests and Quizzes’ on OWL
Describing Risky Outcomes
Random Event: An event that has several possible outcomes, each of which is
uncertain
Each outcome occurs with some probability
eg. rolling a die (there are 6 possible outcomes, each with a 1/6 chance of being
rolled)
If you have listed all of the possible outcomes, their occurrence will sum to 1
o1/6 + 1/6 + 1/6 + 1/6 + 1/6 + 1/6 = 1
We can create a Probability Distribution for the random event.
A probability distribution tells us all of the possible outcomes that could occur,
and their associated probabilities of occurrence.
Example: A stock price is currently $100. There is a 30% chance that the stock price
increases to $120, a 40% chance that the stock price stays the same, and a 30%
chance that the stock price decreases to $80.
We can create a probability distribution from this information.
oThere are only 3 possible outcomes, and they all have their own
probability of occurrence (which will sum to 1)
You can view the graph in Figure 15.2 (page 1 of your notes)
We describe a random event using:
1. Expected Value
E(x) =
xP(x)
2. Variance
Describes the spread in outcomes
Variance represents riskiness – the higher the variance, the higher the
uncertainty of your outcomes
.
x
[x – E(s)]2P(x)
Example from above stock price: v(x) = (80-100)2(.3) + (100 – 100)2(.4) +
(120 – 100)2(.3) = 240
3. Standard Deviation =
variance
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