Decision Making Under Uncertainty (HINDI)

Decision Making Under Uncertainty: That risk is a key feature of the economy and that most people are risk-averse. A random variable is a variable with an uncertain future value. The expected value of a random variable is the weighted average of all possible values, where the weights on each possible value correspond to the probability of that value occurring. A state of the world is a possible future event. Risk is uncertainty about future outcomes. When the uncertainty is about monetary outcomes, it becomes a financial risk. Expected utility is the expected value of an individual’s total utility given uncertainty about future outcomes. A premium is a payment to an insurance company in return for the insurance company’s promise to pay a claim in certain states of the world. A fair insurance policy is an insurance policy for which the premium is equal to the expected value of the claim. Risk-averse individuals will choose to reduce the risk they face when that reduction leaves the expected value of their income or wealth unchanged.
The expected value of a random variable is the weighted average of all possible values, where the weight corresponds to the probability of a given value occurring.
Uncertainty about states of the world entails risk, or financial risk when there is an uncertain monetary outcome. When faced with uncertainty, consumers choose the option yielding the highest level of expected utility.
Most people are risk-averse: they would be willing to purchase a fair insurance policy in which the premium is equal to the expected value of the claim.
Risk aversion arises from diminishing marginal utility. Differences in preferences and income or wealth lead to differences in risk aversion.
Depending on the size of the premium, a risk-averse person may be willing to purchase an “unfair” insurance policy with a premium larger than the expected claim. The greater your risk aversion, the greater the premium you are willing to pay. A risk-neutral person is unwilling to pay any premium to avoid the risk.

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