Probability: is the likelihood that a given outcome will occur
Subjective probability is the perception that an outcome will occur. This perception on a person's judgment or experience, but not on the frequency with which a particular outcome has actually occurred in the past.
Expected value: weighted average of the payoffs or values associated with all possible outcomes. The probabilities of each outcome are used as weights.
E(x)= P1X1 + P2X2 =(1/4)($40 /share) + (3/4)($20/share) = $25/share
Variance and Standard Deviation: look notebook (The higher the risk the higher is stad devi)
Find E(X)
Find deviation=
Square deviation then find Variance
Stand deviation= Square root of Variance
Preferences toward risk expected utility E(u) = 0/2)u($10,OOO) + 0/2)u($30,OOO) = 0.5(0) + 0.5(8) = 14
Risk averse prefers a certain given income to a risky income with the same expected value.
Risk neutral is indifferent between a certain income and an uncertain income with the same expected value.
Risk loving prefers an uncertain income to a certain one, even if the expected value of the uncertain income is less than that of the certain income.
The risk premium is the maximum amount of money that a riskaverse person will pay to avoid taking a risk.
The demand for risky assets
A risky asset provides a monetary flow that is at least in part random. The monetary flow is not known with certainty in advance. a riskless (or risk-free) asset pays a monetary flow that is known with certainty.
Real return= normal return-inflation rate
Equation; look notebook
Production Function
Inputs or factors of production= labor, capital, natural resources
Production function indicates the highest output q that a firm can produce for every specified combination of inputs.
Isoquant is a curve that shows all the possible combinations of inputs that yield the same output.
Production Options in the Short run
Total product
Average product= Output/labor input = q/L
Marginal product= Change in output/ change in labor input
When marginal product=average product= maximum production law of diminishing marginal returns states that as the use of an input increases in equal increments (with other inputs fixed), a point will eventually be reached at which the resulting additions to output decrease.
Input substitution in the long run marginal rate of technicalsubstitution (MRTS) Amount by which the quantity of one input can be reduced when one extra unit of another input is used, so that output remains constant.
MRTS= - Change in capital input/ change in labor input = - change K/ change L (for a fixed level of q)
(MPL) / (MPK) = -(L'lK/ L'lL) = MRTS
2 Exceptions look notebook
Long run