Intermediate micro economics – term 1 Assessments – 2 quizzes that count for 30% - quiz 1 November 15th and quiz 2 December 19th 1 assessment that counts for 70% - January tbd Uncertainty notes – topic 3 (from slides) Expected value = probability x payoff Expected utility = probability x utility Axioms of Expected utility - Completeness, either a>b b>a or a=b Reflexivity, a >= a Transitivity, if a>b and b>c a>c Independence of irrelevant alternatives, if a>b, then a + c is still > than b + c Continuity, if a>b>c, then there must exist a value p where pa + (1-p)c = b Ordinal utility – any utlity function that preserves the preference ordering, so if U=x then the order will be the same if we have U=1/2x or U=10x but not if we have U=1/x vNM utility is cardinal – it’s all about magnitude. A vNM utility function reflects a person’s RISK PREFERENCES Risk averse – chooses a certain outcome over a fair gamble - The 2nd derivative of the utility function will be negative – shows diminishing marginal utility A FAIR gamble Is one that has the same expected VALUE as the certain outcome Risk seekers are the opposite with them preferring the fair gamble over the certainty. - The 2nd derivative for this group is positive showing increasing marginal utility Risk neutrals are indifferent and have a 2nd derivative utility function = 0 An example explanation – I prefer the certainty of A over the fair gamble of B as B has higher risk and no higher e Certainty equivalents “the amount of a certain payoff that would make a person indifferent between a lottery and a certain payoff” Insurance Risk averse people are willing to pay high insurance premiums whilst risk seeking might not bother at all.
