Week 2

Question 1

What is the difference risk and uncertainty?

Answer 1

Risk refers to when the probability is known, uncertainty is when the probabilities are unknown.

Question 2

What is ℒa?

Answer 2

The space of simple lotteries on A

Question 3

When is a preference relation continuous on ℒa?

Answer 3

if for each triple of lotteries p;p0;p00 2 in LA, it holds that the sets
{𝛼 in [0, 1]: p+(1 - 𝛼)p0 (pref) p00} and
{𝛼 in [0,1]: p00 (pref) p+(1 - 𝛼)p0} are closed sets.

Question 4

What is a simple lottery?

Answer 4

A lottery where the outcome is decided in one round

Question 5

What is consequentialism?

Answer 5

The belief that the consequences of one’s actions are the ultimate basis about the rightness or wrongness of that conduct.

Question 6

What is a Two-Stage Lottery?

Answer 6

A lottery where the outcome is decided in two rounds.

Question 7

What is the reduction axiom?

Answer 7

The reduction axiom hold if for p’, p’’ in La, alpha in [0, 1] and p = alpha p’ + (1 - alpha)p’’ in La. Then the preference relation on La satisfies the reduction axiom if for all p’, p’’ in La alpha in [0, 1] it holds that p (indifference) alpha p’ + (1 - alpha) p’’

Question 8

What is the independence axiom?

Answer 8

The preference relation on La satisfies the independence axiom if for all p, p’, p’’ in La and all alpha in [0, 1] it holds that p (pref) p’ <==> alpha p + (1-alpha)p’’ (pref) alpha p’ + (1 - alpha) p’’

Question 9

What is the expected utility theorem?

Answer 9

U(p) = sum j =1 to m p.j u(a.j)

Question 10

When is a decision maker risk averse?

Answer 10

If Cp < E(p)

Question 11

What is loss aversion?

Answer 11

People would rather take a larger expected loss, if there is a chance of smaller or even no loss.

Question 12

What is the Ellsberg paradox?

Answer 12

People prefer known probabilities, over unknown probabilities, this is called ambiguity aversion.

Question 13

What is a maxmin utility function?

Answer 13

Individuals maximize subjective expected utility with the worst-case scenario for each lottery in mind.

Question 14

What is ambiguity aversion?

Answer 14

People prefer known risks over unknown probabilities.