MGEB02H3 Chapter : Week 7 chapter notes

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lavenderdonkey6

5 Dec 2010

School

UTSC

Department

Economics for Management Studies

Course

MGEB02H3

Professor

A.Mazaheri

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Document Summary

N mutual fund firm that pools funds of individual investors to buy large number of diverse stocks or other financial assets. Summary: consumers and managers frequently make decisions in which there is uncertainty about the future. This uncertainty is characterized by the term risk, which applies when each of the possible outcomes and its probability of occurrence is known: consumers and investors are concerned about the expected value and the variability of uncertain outcomes. The expected value is a measure of the central tendency of the values of risky outcomes. The maximum amount of money that a risk-averse person would pay to avoid taking a risk is called the risk premium. A person who is indifferent between a risky investment and the certain receipt of the expected return on that return is risk neutral.

Related Questions

The following payoff matrix shows the profit outcomes for threeprojects, A, B, and C, for each of two possible product prices.There is a 60% probability the price will be $10 and a 40%probability the price will be $20.
Profit
Project P = $10 P = $20
A 20 80
B 40 60
C -26 140

a. Using the maximum expected value rule a decision maker wouldchoose project B. Explain.
b. Using the mean variance rule a decision maker would also chooseproject B. Explain Why.

Supposed a proposed public policy could result in three possible outcomes:

1. Present value of net benefits of $4,000,000;

2. Present value of net benefits of $1,000,000;

3. Present value of net benefits of -$10,000,000 (yes, it is a loss).

If the probability of each outcome is, respectively, 0.85, 0.10, and 0.05, should the policy be pursued or not? Explain. (3 points)

violetgoat484

Uncertain externality

The health and environmental damages associated with the production of GMO crops is uncertain. Without intervention, agricultural producers will adopt GMO crops (whether or not it is rational to do so). A regulator can choose to prohibit the use of GMO crops, in which case the benefits and costs would be 150 and 50, respectively. The increased yields associated with GMO production will lead to greater benefits of 200. The regulator has placed a subjective probability of 0.9 that the use of GMO products will only result in a small increase of costs (cost is 60) and 0.1 probability that their use will result in a catastrophe (cost is 400).

(a) What is the expected value of GMO production? What is the certain value of non-GMO production?

(b) Would a risk-neutral regulator intervene?

(c) Suppose that a social planner has the following utility function: U(W) = W^(1/2), where W is the total welfare experienced by society. He generates 200 units of welfare from activities not related to GMOs. What is his expected utility from GMO adoption? Prohibiting GMOs?

(d) Would the risk-averse planner prohibit the use of GMOs?

champagneoyster557

MGEB02H3 Chapter : Week 7 chapter notes

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