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Unit-28: Economics of Risk and Uncertainty

Suppose that tossing the coin between two players, this is decided that of first time tossing the coin Notes
comes head then the player will get 100 and if comes tail he will have to pay 60. According to
Table 2, the probability distribution is respectively 0.6 and 0.4 then the expected value of this condition
is as follows—

Table 2

Incident Result Probability
Win 100 0.6
Loose – 60 0.4

The expected value or payment of player is 36 means.
∑ = 0.6 ( 100) + 0.4 ( 60) = 60 –24 = 36.
v

28.1 Individual Consumer’s Behaviour Towards Risk

The traditional utility analysation is the behaviour of a consumer in between the risk free and the certain
selection. Newmann and Morgenstern studied the behaviour of a man based on its risky selection of
expected utility by gamble, lottery tickets. Freidman and Sewage, and later Markowitz amended the
theory implementing in purchasing the insure for risk.
We study the risk preference of a man to understand the individual behaviour for risk.

Self Assessment

Fill in the blanks:
1. Uncertainty is the ......................... fact of human life.
2. The difference in Risk and ......................... is necessary to know.
3. The uncertainty is the situation, where the possible ........................ .

28.2 Risk Preference: Attitude Towards Risk

The attitude towards risk of a man depends on his selections and its expected profit to be received.
Generally, this is expected that high risk–high gain. A personal decision shows the risk preference or the
attitude of a person and the preferences are different in every individual. Some people like to take risk,
some against to take risk and some neutral to take risk. The people, who take risk, expect more return
profit, monetary income and utility.
To describe the attitude towards risk of a man, we can present the example of gamble. The players are
paid while tossing coin in the gamble. Suppose that a person has 10,000 and he bet for 10,000. If he
wins the game then he will receive the 10,000. In reverse condition the amount will be lost by him.
This way, both results are expected. Means every result has 50% possibility. In this game the expected
value —E or payoff is—
v
E = 0.5 ( 10,000) + 0.5 (– 10,000) = 5,000 – 5,000 = 0. This is a fair game of honesty in which the
v
result of expected value is 0.
The attitude towards risk of a man are of three kinds which depend on this factor that the man accept
the fair game or not.

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