Choice under Uncertainty Stanford University（不确定性下的选择斯坦福大学）.pdf

Choice under Uncertainty Jonathan Levin October 2006 1 Introduction Virtually every decision is made in the face of uncertainty. While we often rely on models of certain information as you’ve seen in the class so far, many economic problems require that we tackle uncertainty head on. For instance, how should in- dividuals save for retirement when they face uncertainty about their future income, the return on different investments, their health and their future preferences? How should firms choose what products to introduce or prices to set when demand is uncertain? What policies should governments choose when there is uncertainty about future productivity, growth, inflation and unemployment? Our objective in the next few classes is to develop a model of choice behavior under uncertainty. We start with the von Neumann-Morgenstern expected utility model, which is the workhorse of modern economics. We’ll consider the foundations of this model, and then use it to develop basic properties of preference and choice in the presence of uncertainty: measures of risk aversion, rankings of uncertain prospects, and comparative statics of choice under uncertainty. As with all theoretical models, the expected utility model is not without its limitations. One limitation is that it treats uncertainty as objective risk – that is, as a series of coin flips where the probabilities are objectively known. Of course, it’s hard to place an objective probability on whether Arnold Schwarzenegger would be a good California governor despite the uncertainty. In response to this, we’ll discuss Savage’s (1954) approach to choice under uncertainty, which rather than assuming the existence of objective probabilities attached to uncertain prospects 1 makes as