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

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2 Nov 2016
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
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
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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