MGT 621 – Microeconomics
3. Choice Under Uncertainty
Lecture Notes (Overheads Used In Class)
· Pindyck/Rubinfeld, Ch. 5
· What is the difference between risk and uncertainty? Provide some examples.
· Show that any utility representation for preferences over lotteries is invariant with respect to a positive linear transformation, and argue why nonlinear increasing transformations do not work (unlike in the case without uncertainty).
· Show that limited liability can induce risk-seeking behavior.
· Why do risk-neutral innovators like risk? [Hint: Argue that their payoff profile looks like a call option.]
· Explain how loss aversion and risk aversion induce a status quo bias.
Background Reading (for future reference only)
· Notes on Risk Aversion in the Small and in the Large (an interesting problem)
· Notes on the Value of a Call Option (an application of second-order stochastic dominance)