Probabilistic Microeconomics

Abstract

This paper is a survey of recent developments in probabilistic microeconomics. While research on the foundations of utility theory is not reviewed, a general Von Neumann-Morgenstern model of decision-making under uncertainty is presented. Alternative measures of risk aversion are examined within the context of decision-making by both competitive and monopolistic firms. The behavior of these firms is strongly influenced by their attitudes toward risk, and many of the conventional deterministic results are, in general, not true in a world of uncertainty. Several methods for ameliorating the effects of uncertainty are investigated. All are special cases of insurance and include ordinary insurance policies for contingencies like fire, theft, accident, etc., and more subtle variations like preventive maintenance and inventory control. A useful device for analyzing behavior under uncertainty is also discussed. This is martingale theory, which was developed by probabilists and appears to have many applications in the economics of uncertainty.

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