1. L12
Uncertainty

2. Three Applications Model with real endowments 1. Labor Supply
(Labor-Leisure Choice)
2. Intertemporal Choice
(Consumption-Savings Choice)
3. Uncertainty (Insurance)
(Consumption across states of the world)

3. Uncertainty Two States of the world: no rain and rain Probabilities
Goods: consumption
Endowment: wealth in two states
Possibility of insurance

4. Budget Constraint

5. Uncertainty and Lotteries

6. Translation: (“as if” markets)

7. Preferences and Utility
Uncertainty – special preferences
Von Neumann-Morgenstern
is a Bernoulli utility function
Expected Utility
Useful property:

8. Risk aversion (uncertainty)
Bundle defines a lottery
Expected value: “Average payment”
Examples
Risk aversion
better than

9. Risk attitudes
Example 1:
Example 2:
Example 3:

10. Utility and Risk Aversion

11. Uncertainty (three functions)

12. Choice of Insurance

13. Magic Formulas
Bernouli utility:

14. Fair Insurance Fair Insurance, why? Expected profit
Free Entry and Law of Large Numbers

15. Insurance

16. Not Fair Insurance When Insurance is not fair
In optimum: (First secret of happiness)

17. Certainty Equivalent Certainty equivalent of lottery Example
Risk Aversion: