MGT 621 – Microeconomics

3. Choice Under Uncertainty

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       Lecture Notes (Overheads Used In Class)

· Lecture 3 - Slides

Reading (Preparation)

· Pindyck/Rubinfeld, Ch. 5

Questions (Preparation)

· 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 and Uncertainty

· 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)