Expected values and risk preferences

Question 1

What are some sources of uncertainty in climate change?

Answer 1

Some sources of uncertainty in climate change include

• climate sensitivity
• unknown unknowns
• the location of tipping points
• the shape of damage functions
• the discount rate

Question 2

How can the acceptance of risk be measured in decision-making scenarios?

Answer 2

In decision-making scenarios involving risk, the acceptance of risk can be measured by determining the minimum probability (p) that would make someone turn down a particular opportunity or offer.

Question 3

What is the formal representation of a lottery in decision-making scenarios?

Answer 3

A lottery is represented by L, which includes different outcomes with associated probabilities.

It could be (as used as an example in class) the choice between a dream job (with probability 1-p) and a plane crash (with probability p), compared to a safe alternative.

Question 4

What is incommensurability in the context of decision-making?

Answer 4

Incommensurability refers to situations where certain values or criteria cannot be accurately weighed or compared due to their radical differences.

Examples include preserving a traditional culture vs. material income, biodiversity vs. human wellbeing, and one person’s wellbeing vs. another’s.

Question 5

What is the expected value (EV) of a lottery?

Answer 5

The expected value (EV) of a lottery represents the average value one can expect to receive from the lottery based on the associated probabilities of different outcomes.

Question 6

How can risk tolerance be classified based on the acceptance of risk?

Answer 6

Risk tolerance can be classified into three categories based on the acceptance of risk:
risk neutral (w = 0.0447),
risk seeking (w > 0.0447), and
risk averse (w < 0.0447)

Question 7

What is the common risk attitude among most people?

Answer 7

Most people are considered risk-averse, meaning they have a lower tolerance for risk and are more cautious in accepting uncertain outcomes.

Question 8

Calculate the expected value (EV) of this lottery:
Outcome 1: Winning $10 with a probability of 0.6
Outcome 2: Losing $5 with a probability of 0.4

Answer 8

Here’s the formula to calculate the EV:

EV = (Outcome1 * Probability1) + (Outcome2 * Probability2) + … + (OutcomeN * ProbabilityN)

To calculate the EV:
EV = ($10 * 0.6) + (-$5 * 0.4)
EV = $6 - $2
EV = $4

In this example, the expected value of the lottery is $4. This means that, on average, a participant can expect to gain $4 from playing the lottery.