ECO101H1 Chapter Notes - Chapter 16: Marginal Utility, Risk Aversion, Risk Neutral
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ECO101H1 Full Course Notes
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Uncertainty, risk, and private information: random variable: uncertain future value, expected value: (of random variable) weighted average of all possible values. Likelihood of taking gamble also depends on risk of gamble: states of the world: possible future events, prefer to reduce risk (uncertainty about future outcomes, all decisions involve uncertainty. Risk aversion: expected utility: expected value of total utility given uncertain future outcomes. Greater for certain outcome than for gamble with same expected value because of. Prefer gamble with greater expected utility diminishing marginal utility: fair insurance policy: insurance policy where premium equals expected value of claim, insurance increases utility. Increases even if expected income doesn"t change because of diminishing marginal utility: risk-averse individuals choose to reduce risk if it leaves expected income unchanged. Does not mean give up all gambles. Will take gamble if probability of good outcome increases, increased expected value of gamble versus for certain outcome: risk-neutral: person completely insensitive to risk, differ in risk aversion.
