Week 1
Pareto efficient: If having a other equilibrium another person have to become better
and other person becomes worser
❖ expected value of income = P*x1 + Px2
❖ The utility of the expected value (uncertain outcome) = Does not consider risk
❖ The expected utility of income (certain income) = Does consider the risk
Risk attitudes
- Risk averse: Utility of expected value > expected utility (Uncertain income < certain
income)
- Concave function
- Risk loving: Expected utility > Utility of expected value (Certain income < Uncertain
income)
- convex function
- Risk neutral: Expected utility = Utility of expected value (indifferent)
- linear function
Knowing if it is concave or convex
- Take second derivative
- → if negative = concave (risk averse)
- → if positive = convex (risk loving)
Risk premium = Expected value - CE
How much a risk averse person is willing to pay to avoid risk, the maximum willingness to
pay to avoid risk
Certainty equivalent = expected utility
MEASURES OF RISK AVERSION
- Using Arrow-Pratt
1. Absolute risk aversion (the amount of euro’s invested)
, 2. Relative risk aversion (the fraction amount invested on the wealth total)
RRA * X =m ARA
HOW ABSOLUTE/RELATIVE RISK AVERSION → CHANGE WITH WEALTH
Absolute risk aversion
Relative risk aversion
INTER TEMPORAL CHOICE
- people mostly wants to consume now and not in the future
- including time differences
- Indifference curve: convex → shows the individuals preferences for consumption in
different time periods
- the discount rate, future periods are discounted
,CONSISTENT TIME PREFERENCES
- following original plan → time consistent
- want to change his plan afterhand → time inconsistent
- Allocating a fixed budget for each period → use langrangia
*Player following the hyperbolic discounting → wants to change plans (Time Inconsistent)
* Player following the exponential discounting → always stick to the plan (Time consistent)
SELF AWARENESS
= comparing expected behavior with actual behavior
- Time incostentent players may or not may aware that their preferences will change
over time
- completely naive (B=1) → believes that preferences will be identical to current
preferences
- Completely sophisticated (B^ = B) → correctly predict how preferences will
change over time
By O’Donoghue and rabin (2001)
- B^ = Expected level of present bias
- B = the true level
- Investment goods → consumption with future benefits
- 1 > B^ > B (overestimation of consumption)
- Leisure goods → consumption with future costs
- 1 > B^ < B (underestimation of consumption)
, WEEK
2
STRATEGIC INTERACTIONS = studied in game theory
Public goods → nobody will contribute because they will own the profit without costs
Difference behavior economics and mainstream economics (Rational theory) (Standard) by
Rabin
Agents are not always:
- 100% self-centered (no pure self interest)
- 100% rational (not perfect calculators)
- 100% self controlled (time inconsistency)
MEAUSRING THE MONOPOLY POWER
→ use the lerner index
L = (P-MC)/P
MARKETS
Competitive market → price takers, P=MC
Monopoly → MR = MC
Oligopoly = only a few sellers
- The products may or not be differentiated
- barriers to entry
- natural barriers to entry
- scale economies
- patents
- reputation
Duopoly = only 2 sellers
DIFFERENCE DECISION THEORY AND GAME THEORY
- Decision theory
Pareto efficient: If having a other equilibrium another person have to become better
and other person becomes worser
❖ expected value of income = P*x1 + Px2
❖ The utility of the expected value (uncertain outcome) = Does not consider risk
❖ The expected utility of income (certain income) = Does consider the risk
Risk attitudes
- Risk averse: Utility of expected value > expected utility (Uncertain income < certain
income)
- Concave function
- Risk loving: Expected utility > Utility of expected value (Certain income < Uncertain
income)
- convex function
- Risk neutral: Expected utility = Utility of expected value (indifferent)
- linear function
Knowing if it is concave or convex
- Take second derivative
- → if negative = concave (risk averse)
- → if positive = convex (risk loving)
Risk premium = Expected value - CE
How much a risk averse person is willing to pay to avoid risk, the maximum willingness to
pay to avoid risk
Certainty equivalent = expected utility
MEASURES OF RISK AVERSION
- Using Arrow-Pratt
1. Absolute risk aversion (the amount of euro’s invested)
, 2. Relative risk aversion (the fraction amount invested on the wealth total)
RRA * X =m ARA
HOW ABSOLUTE/RELATIVE RISK AVERSION → CHANGE WITH WEALTH
Absolute risk aversion
Relative risk aversion
INTER TEMPORAL CHOICE
- people mostly wants to consume now and not in the future
- including time differences
- Indifference curve: convex → shows the individuals preferences for consumption in
different time periods
- the discount rate, future periods are discounted
,CONSISTENT TIME PREFERENCES
- following original plan → time consistent
- want to change his plan afterhand → time inconsistent
- Allocating a fixed budget for each period → use langrangia
*Player following the hyperbolic discounting → wants to change plans (Time Inconsistent)
* Player following the exponential discounting → always stick to the plan (Time consistent)
SELF AWARENESS
= comparing expected behavior with actual behavior
- Time incostentent players may or not may aware that their preferences will change
over time
- completely naive (B=1) → believes that preferences will be identical to current
preferences
- Completely sophisticated (B^ = B) → correctly predict how preferences will
change over time
By O’Donoghue and rabin (2001)
- B^ = Expected level of present bias
- B = the true level
- Investment goods → consumption with future benefits
- 1 > B^ > B (overestimation of consumption)
- Leisure goods → consumption with future costs
- 1 > B^ < B (underestimation of consumption)
, WEEK
2
STRATEGIC INTERACTIONS = studied in game theory
Public goods → nobody will contribute because they will own the profit without costs
Difference behavior economics and mainstream economics (Rational theory) (Standard) by
Rabin
Agents are not always:
- 100% self-centered (no pure self interest)
- 100% rational (not perfect calculators)
- 100% self controlled (time inconsistency)
MEAUSRING THE MONOPOLY POWER
→ use the lerner index
L = (P-MC)/P
MARKETS
Competitive market → price takers, P=MC
Monopoly → MR = MC
Oligopoly = only a few sellers
- The products may or not be differentiated
- barriers to entry
- natural barriers to entry
- scale economies
- patents
- reputation
Duopoly = only 2 sellers
DIFFERENCE DECISION THEORY AND GAME THEORY
- Decision theory
