ECON 101 Lecture Notes - Lecture 17: Uch
1 Jun 2018
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Lastclass
calculat
Expected
value ECW WiPWWi Doesn't
determineiffirmwill
playthe
lotteryornot fairnes
Expected
Utility EfuwuWiPWWi
3certain
Equivalent CE Monetaryequivalentof alotteryanswers How
much
money
would
the
agent
havetopay be
paidin
exchangeof
Not
playing uCE Eu
CW
certain
EX lasttime we compared upayment
zooo vs Elottery where we 3,888
wecanalso
compare2lotteries EcuWi vs ECUWa
Measuresof risk Aversion 2People
MAY
both
beaverse
but Imaybe
more
averse
thanthe
Other
This
determines how
much
insurance
you
buyetc
tells
which
individualismost risk Averse
coefficientof Constant AbsoluteRiskAversion CAR
A
rwa1W
anew Higherracw moreriskaverse
coefficientofRelatedRisk
Aversion CRRA
rn wWihigher rwmoreriskaverse
how
much
Iealthyou
have
already
shows
how
much
moneyyou'rewillingto risklosing
Exampleicompute
CARAfor UWe0W CARA
Function
UWDeOw
Uwgz ow ra wIf g
CARAisconstantfortheCARAfunction
computeCRRAfor uwWOCRRA
function
oooi
UWWOrn wut to also
constant
Uwa1OWOI
Insurancemarkets
Example Ahomeowner
has ahouse
worthof 100000 Hehastodecide
whethertobuyfire
insuranceHeknowsthat
theriskof afire is probability 101 Inthe
caseof fire damageand
Document Summary
3certainequivalent ce monetaryequivalentof a lotteryanswers howmuchmoneywouldthe agenthavetopay bepaidinexchangeofnotplaying u ce e ucw. Ex lasttime we compared u paymentzooo vs e lottery where we 3,888 uwipwwi certain calculat fairnes wecanalsocompare2lotteries ecuwi vs ecuwa. Otherthisdetermines howmuchinsuranceyoubuy etc tellswhichindividualismost risk averse coefficientof constant absoluteriskaversion cara r w a 1w new a. Higherracw moreriskaverse coefficientofrelatedriskaversion crra rn w w i howmuchiealthyouhavealreadyshowshowmuchmoneyyou"rewillingto risklosing higher r w moreriskaverse. U wa 1 o w o i rn w. Example ahomeownerhas ahouseworthof 100000 hehastodecidewhethertobuyfire insurance heknowsthattheriskof a fire is probability 101 inthecaseof fire damageand repairswillcost 50000 assume u w in w hecouldhaveno fire4keep100,000 hecouldhave a fire loseso ooo futureisn"tpredictable. Firescenario soooo p t 501000 insurance p compensation1reimburse. 100 ooo p ourgoal tofindthemaximump thehomeowneriswillingtopay us weneedto find thecertain equivalent ofthelottery question14. Tofind it step calculatetheutility if heplaysthelottery e u w. F u w 0. 9u 100,000 t 0. 1 u so 000. 0. 9in 100,000 t 0. 1in 50,000 a 11. 44 step findthecebyinvertingtheutilityfunction.
