Now we will lift the assumption that consumers and entirely aware of their incomes, preferences, firm offerings, technology, etc. One of the most crucial aspects of uncertainty is that some market actors will be better informed than others. Think of Hayek's Knowledge Problem.
Decisions under Uncertainty
Expected Gain versus Expected Utility
One of the first questions to ask in a decision is which next step will maximize the mathematical expectation (expected value, which is the probability-weighted outcome) of dollar gain. The general rule is this: For any single action, take the value of each possible outcome multiplied by the probability of its occurrence, then some the product. The result is the expected value of that singular action.
Algebraically, suppose the pi term is the probability and the possible states corresponding from a are denoted by V. This can be written:
\(E[V(a_i)] = \pi _1 V_{i 1} + \pi _2 V_{i 2} + ... + \pi _s V_{is}\)
Thus choose the highest a that yields the highest E.
Risk Aversion
Sometimes there are situations in which risk cannot be ignored. Consider that someone has two job offers: one with a steady salary and another with a lower assured salary but high potential bonuses. Although the dollar maximization might be higher on the second, Here we will measure and maximize expected utility versus
The Value of Information
Herd Behavior and Informational Cascades
Copyright, Patents, and Intellectual Property Rights