Intermediate Microeconomic Theory I
ECON 2300 – Summer 2011 – Mark Melatos
Topic 3 – Consumer Choice under Uncertainty – May 26
Choice under Uncertainty
- Consumer face risk:
o Buy an umbrella? (Will it rain?)
o Buy health insurance? (Will I get sick?)
o How much should I spend/save? (How long will I live after I retire?)
o How should I invest my savings? (What will happen to asset prices?)
- Probability: A number between 0 and 1 that indicates the likelihood that a
particular event will occur.
o E.g. probability of heads (tails) is toss a coin = 0.5.
o N = # people in population.
o n = # people who get sick during a flu epidemic
o Probability of getting sick = n/N
Expected Value (Mean, Average)
- The sum of the payoffs (i.e. values) associated with all possible events, weighted
by the probability that each outcome will occur.
- Definition: A risk situation with EV=0 is called a fair bet.
- Variance: describes the ‘spread’ of a distri