In the real market, there are so many uncertainty, i.e. uncertainty of the market, the firm and consumer. It gives implication to managers whenever they want to make decisions.

1. Economics
of
Information
Fadhilah Hana Lestari

2. Overview
1. Uncertainty and Consumer Behavior
2. Uncertainty and the Firm

3. Uncertainty and
Consumer Behavior

4. Risk Aversion
• Risk Averse
Prefer a sure amount of $M to a risky prospect
with an expected value (E[x]) of $M
• Risk Loving
Prefer a risky prospect with an expected value
(E[x]) of $M to a sure amount of $M
• Risk Neutral
Indifferent between a sure amount of $M and a
risky prospect with an expected value where
E[x] = $M

5. Implications of Risk-Averse Consumers
for Managerial Decision
Product Quality
• Case : Risk of using new product.
If consumers think new product is just as good
as current product, they won’t buy the new
product
• What should Manager do?
Free Samples Guarantees
Pantene -
World’s class
Hair Treatment

6. Implications of Risk-Averse Consumers
for Managerial Decision
Chain Stores
• Case : There are a local diner and a national
hamburger chain in a small town. Which one
will out-of-town consumers choose?
They will prefer a national chain, unless they
expect the product of local dinner is better.
The local customer knows better...

7. Implications of Risk-Averse Consumers
for Managerial Decision
Insurance
• Case : Consumers choose to buy insurance
By buying insurance, they give up a small
amount of money to eliminate the risk
• What should Manager do?
– Money-back guarantee
– Extrended-warranty

8. Price Uncertainty and
Consumer Search
• Suppose consumers face numerous stores
selling identical products, but charge different
prices.
• Consumers want to purchase the product at
the lowest possible price, but also incurs a cost
(c) to acquire price information
• The consumer’s reservation price, R, is the
price at which the consumer is indifferent
between purchasing and searching for a lower
price

9. Consumer Search Rule
• When should a consumer stop searching for
price information ?
• Consumer will search until
EB(R) = c
• Therefore, a consumer will continue to search
for a lower price when the observed price is
greater than R and stop searching when the
observed price is less than R.

10. The Optimal Search Strategy
– Accept (P < R)  stop searching and purchase product
– Reject (P > R)  continue to search for a lower price

11. Rising Search Costs
An increase in search cost raises the reservation price 
price is more acceptable and less of searching intensity

12. Uncertainty and The Firm

13. Uncertainty and The Firm
• Risk Aversion
– Are managers risk averse or risk neutral?
• Diversification
– “Don’t put all your eggs in one basket”
• Profit Mazimation
– When demand is uncertain, expected profits are
maximized at the point where expected marginal
revenue equal marginal cost
E[MR] = MC