Page 399 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Microeconomic Theory

Notes 1. Risk Neutral: Such kinds of man play if the odds (possibility) are in his favour. If the odds are
not in favour then he will not take part and plays the neutral fair game.
2. Risk loving: Such kind of man excited to play even if the odds are not in his favour. He will
play the game only for 1,000 possible winning amount losing 10,000.
3. Risk Averse: Such kinds of man will not take part if the odds are not in his favour. But if odds
are in favour in full support then he will be ready to play. A risk average person is not ready
to play even fair game.

Risk Preference and Expected Utility

Generally, men play in casino to earn more money or betting in race which gives them satisfaction.
Economists measure the satisfaction by utility. They describe all the three types of men relating to their
risk preference.

Self Assessment

Multiple choice questions:
4. In all financial transactions, there is ..................... .
(a) element of risk (b) element of expenditure (c) element of profit (d) element of loss
5. Attitude toward, risk of a man is of ................. .
(a) two kinds (b) three kinds (c) four kinds (d) none of these
6. The possibility of incident is the number of occurrences (frequency)–
(a) ration (b) percentage (c) frequency (d) none of these
7. A risk loving man is ready to play earn odds are not in favor–
(a) excited (b) depend (c) desperate (d) none of these

Assumptions

The analysis assumes that—
1. The satisfaction of human is linked with money.
2. Utility is a measure of his satisfaction.
3. Man has a certain amount of assets.
4. He plays the tossing coin game.
5. He knows the all probabilities.
6. His selection is definite.
7. He maximizes the expected utility means he opt the payment or expected utility is maximize.
Having these assumptions, think about a gamble, in which a player is paid after tossing the coin.
Suppose that a man has 10,000 and bet on 5,000. Tossing the coin if head comes, he will earn 5,000
otherwise coming tail he will lose 5,000. If he does not bet definitely he will remain at 10,000. This
situation is called certain prospect. But if he bets either on the possibility of winning 0.5 will get 15,000
( 10,000 + 50,000) or the possibility of losing 0.5 will get 50,000 ( 10,000 – 5,000). This situation
is called certain prospect. It means that the probability of every result has 50 per cent. In this game the
expected value or payoff is—
E = 0.5 ( 5,000) + 0.5 ( 15,000) = 25,00 + 75,00 = 10,000
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