Lecture 2

Question 1

business risk

Answer 1

doing business involves uncertainty that cannot be insured against
profit is the reward

Question 2

Examples

Business Risk

Answer 2

entry of new arrivals in business
adoption of new technologies by rivals
government regulations interfering with business
sudden decrease in demand for no reasond

Question 3

Uncertainty & Market Imperfections

Answer 3

imperfect information
costly, unavailable, private, asymmetric (hidden characteristics or actions)
optimising may be difficult
transaction cost (inspection cost)
market failure - mistrust (is the product worth the price?)
need for incentive - link wages to motivate to be more productive

Question 4

Knight 1921

Answer 4

firm exist as carrying out business requires decisions in which the consequences are unisurable

Question 5

Increase in Scope of FIrm

Answer 5

specialise in decision making
single businessman can extend scope of exercise judgement over greater number of decisions, greater probability of bad guesses will be offset by good ones
degree of consistency can be achieved

Question 6

Pareto Efficiency

Answer 6

most effcient combination

Question 7

Employer

Answer 7

degree of confidence in judgement and back up with specialise in risk taking
superior managerial ability within productive groups (foresight & capacity of ruling over others)
adaption of basis of knowledge of judgement in uncertainty

Question 8

double-contract

Answer 8

impracticable to guarantee to another definite results of actions without being given the power to direct his work and second party won´t place himself in such direction without such guarantee

Question 9

Consequence - society

Answer 9

function of enterprise and wage system of industry
entrepeneur producers pay guaranteed fixed renumeration to the masses for productive services and certainty
entrepeneur keeps profit since he bears the risk
pareto efficient as total welfare increases and less risk averse bears the risk

Question 10

Expected Wealth

Answer 10

isn´t actual outcome under risk (as it can either be one or the other situation)
theoretical superposition value of your wealth in case of not be insured for the risk
expected wealth on average

Question 11

Risk Aversion

Answer 11

experienced a diminishing marginal utility of wealth
each subsequent increase of wealth level the effective increase in utility will be lower
scarcity makes a good more valuable

Question 12

Difference in utility values

Answer 12

surplus gain (benefit) of purchasing insurance and assured to receive a certain amount of wealth at the end of the period - no matter what happen

Question 13

risk aversion consequences

Answer 13

react negatively to uncertainty effects on production
might be reluctant to react accordingly and manage risk efficiently
make objective/rational decisions

Question 14

Risk Preference

Answer 14

risk affiliation in making decision under uncertainty
define uncertainty & risk
business decisions involves uncertainty (market economy)
better at making judgement of future outcomes (dealing or reacting to it)
form of utility curve !!!

Question 15

Risk attitude

Answer 15

2 types of risk attitudes
individuals differ in comfort with uncertainty based on circumstances they face and risk preferences
compare diff. alternatives/payoffs and degree of risk
change ove time

Question 16

Premium

Answer 16

insurance companies
lower returns for less risky investments
higher charger if riskier work or higher fess paid to a more reputable contractor