Economic Decisions Under Uncertainty

Bol Partner

The Fundamental Issues Involved Why do we need a theory of uncertainty? It is a fact that almost all man's economic decisions are made under conditions of uncertainty, but this fact alone does not provide a strong enough argument for making the effort necessary to generalize ordinary preference theory designed for a world of perfect certainty. In accordance with Occam's Razor, the mathematician may well welcome a generalization of assumptions even if it does not promise more than a restatement of known results. The economist, however, will only be well disposed towards making the effort if he can expect to achieve new insights and interesting results, for he is interested in the techniques necessary for the generalization only as means to an end, not as ends in themselves. A stronger reason for developing a theory of uncertainty, therefore, seems to be the fact that there are kinds of economic activities to which the non-stochastic preference theory has no access or has access only through highly artificial constructions. Such activities include portfolio decisions of wealth holders, speculation, and insurance. These will be considered in detail in the last chapter of the book. The main purpose of this book, however, is not to apply a theory of uncertainty to concrete economic problems, the purpose rather is to formulate such a theory.

Bol

A stronger reason for developing a theory of uncertainty, therefore, seems to be the fact that there are kinds of economic activities to which the non-stochastic preference theory has no access or has access only through highly artificial constructions. This book gives an overview of central issues in the theory of economic decision making under uncertainty. It makes extensive use of the location and scale parameter model that was discussed in the American Economic Review of 1987 and 1989 by Jack Meyer and the author. Among the topics treated in the book are the following: A Rehabilitation of the Principle of Insufficient Reason - Psychophysical laws in risk theory - The Law of Large Numbers and expected utility - Risk aversion in intertemporal models - limited liability and decision making under risk - Theory of Speculation - Theory of Insurance and Moral Hazard.