# 01:220:395 Lecture Notes - Lecture 3: Indifference Curve, Adverse Selection, Standard Deviation

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2 Nov 2016

School

Department

Course

Professor

Exam 3

Chapter 7

Relaxed Assumptions

Decision makers are rationally self interested

There are no regulations to reduce external costs

There is no insurance

All injurers are solvent and pay damages in full

Litigation costs are zero

Nonrational Decisionmakers

Cost benefit analysis

Estimate probability incorrectly

Math errors

Media distorts event probability

Risk lovers vs. risk avoiders

Calculate risk – standard deviation

Asymmetric information

The unequal knowledge that each party in a transaction has about the other

party

Adverse selection

Situation in which asymmetric information causes higher risk customers to

be more likely to purchase or sellers to be more likely to supply low quality

goods

Examples: high risk homeowners buying insurance

Sellers of used cars

Moral Hazard

a situation that occurs when as a result of having insurance, an individual

becomes more likely to engage in risky behavior

1. Subjective probability – person’s degree of certainty of an event occurring

2. Probability

3. Probability and outcome projected profit 8-9

4. Risk adverse and risk loving people

5. Variance = std squared

6. Profits with each probability

7. Adverse selection definitions

8. Adverse selection and moral hazard examples 8-9

9. Definitions of utility, perfect compensation, adverse selection, tort,

indifference curve, perfect information, breach of duty 8-9

10. Calculate variance, standard deviation

11. Email for problems in class

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