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Explain the Significance of the St. Petersburg Paradox, Common Ratio Effect and Simultaneous Gambling and Insurance, and Their Implications for Expected Utility Theory. Essay

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Below is an essay on "Explain the Significance of the St. Petersburg Paradox, Common Ratio Effect and Simultaneous Gambling and Insurance, and Their Implications for Expected Utility Theory." from Anti Essays, your source for research papers, essays, and term paper examples.

                The analysis of decision under risk requires a different approach to that of standard consumer (and producer) theory, uncertainty is pervasive therefore an extension of theory needs to take uncertainty into account. Uncertainty arises because the consequence of at least one option to the decision maker is unknown (i.e. is not a single sure outcome, but a number of possible outcomes) (Gravelle, Reese. 2004) however we assume that the probabilities of the possible outcomes are known. The clearest examples of individual’s choice between uncertain options are provided by gambling and insurance. An individual who purchases home insurance is accepting the certain loss of a small premium in preference to the combination of a small chance of a much larger loss (fire, theft etc) and a large chance of no loss. He pays a premium to avoid risk as he prefers certainty to uncertainty, he is risk averse.  An individual who purchases a lottery ticket is subjecting himself to a large chance of losing a small amount (£1 for lottery ticket) and a small chance of winning a large amount, rather than keeping his £1 to avoid risk all together (Friedman, Savage. 1948). This individual prefers uncertainty to certainty, he is risk loving. Any decision under risk can be represented by a choice among lotteries or prospects. For example, the possible options when purchasing a lottery ticket are; keep your £1 with certainty (probability of 1), or purchase a ticket costing £1 with, say a 1/14m chance of winning the jackpot of 10m, and a probability of 1-1/14m of losing your original £1. This can be represented in the general form of a lottery, [(x1,p1), (x2,p2), ... ,(xn,pn)] where xi are any objects, usually units of wealth that the individual will get if state i occurs, and pi the probabilities of these states occuring, summing to 1. 
                        Keep £1: [£1, 1]             Buy lottery ticket: [(£0, 1-1/14m), (£10m,1/14m)]
                In choosing among...

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"Explain the Significance of the St. Petersburg Paradox, Common Ratio Effect and Simultaneous Gambling and Insurance, and Their Implications for Expected Utility Theory.". Anti Essays. 10 Dec. 2018

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Explain the Significance of the St. Petersburg Paradox, Common Ratio Effect and Simultaneous Gambling and Insurance, and Their Implications for Expected Utility Theory.. Anti Essays. Retrieved December 10, 2018, from the World Wide Web: http://parimatch-stavka7.com/free-essays/Explain-The-Significance-Of-The-St-384077.html


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