A Short Course in Intermediate Microeconomics with Calculus

In most of this book we have assumed perfect information. That is, we have assumed that every buyer and every seller of every good and service in the market has complete information about all the relevant facts. All the buyers and all the sellers know the market prices, and they all know the characteristics of the things being bought and sold. In the next two sections of this chapter we will lay out the basic model of consumer behavior under uncertainty, developed by John von Neumann (1903-1957) and Oskar Morgenstern (1902-1977). This model gives a utility function that can be used to analyze uncertainty. Then we will turn to some examples, which show how the von Neumann-Morgenstern utility function approach can be applied to consumers who want to reduce or avoid risk, and to consumers who like risk and want to increase it. The examples also show how people can trade risk in ways which make everybody better off.