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EC4004 Lecture 6 Risk and Game Theory
 

EC4004 Lecture 6 Risk and Game Theory

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    EC4004 Lecture 6 Risk and Game Theory EC4004 Lecture 6 Risk and Game Theory Presentation Transcript

    • EC4004 Lecture 6 Probability and Game Theory Dr Stephen Kinsella
    • A Panda is for life. Not Just for The Debs.
    • Today
    • 1. Risk
    • 2. Insurance
    • 3. Game Theory
    • Yesterday
    • 1. Risk
    • 4 Ideas:
    • 1. Probability: Average Frequency of events
    • 2. Expected value of game with a number of uncertain outcomes: size of prize player will win on average.
    • 3. Fair games are games that cost precisely their expected value.
    • 4. Risk aversion is tendency for people to refuse to accept fair games.
    • Combine 4 ideas with Diminishing Marginal Utility to get:
    • Utility U 0 20 30 33 35 40 50 Income (thousands of euros)
    • Utility U 0 20 30 33 35 40 50 Income (thousands of euros) Here’s a person a person with three options. Contender may: 1. retain current income level (€35,000) without taking any risk; 2. take a fair bet with a 50-50 chance of winning or losing €5,000; 3. take a fair bet with a a 50-50 chance of winning or losing €15,000.
    • 2. Insurance
    • Utility U U1 Income 0 20 25 35 (thousands of euros)
    • Utility U U1 Income 0 20 25 35 (thousands of euros) Assume that during next year a person with €10,000 current income faces a 50 percent chance of incurring €4,000 in unexpected medical bills. Without insurance, the person’s utility would be U1, - i.e. the utility of the average of €6000 and €10,000.
    • 3. Game Theory
    • Study of Strategic Interaction
    • Study of Strategic Interaction
    • 3 Components to Any Game
    • 1. Players
    • 2. Payoffs
    • 3. Strategies
    • Equilibrium
    • A Nash equilibrium is a set of strategies, one for each player, that are each best responses against one another.
    • In a two-player games, a Nash equilibrium is a pair of strategies (a*,b*) such that a* is an optimal strategy for A against b* and b* is an optimal strategy for B against A*.
    • A Beautiful Mind
    • Next Time: More Game Theory Iterated Prisoners Dilemma Try 6.1, 6.3, 6.5
    • EC4004 Lecture 6 Probability and Game Theory Dr Stephen Kinsella