9. Risk and Uncertainty

Micro treated one person's risk aversion and one firm's expected profit separately; in macro, those attitudes add up and move the economy itself. Faced with risk — probabilities known — people buy insurance and firms lean on diversification. But when uncertainty grows, with the probabilities themselves unknown, households retreat into precautionary saving and firms into wait-and-see, and demand freezes even though no average has worsened. This chapter traces both attitudes from the person to the economy.

• Expected Utility vs Expected Profit — In micro, one person's attitude to risk and one firm's choice were studied apart. In macro, those attitudes add up and move the whole economy. People dislike shaky outcomes, so they buy insurance. Given the same average, they pick the sure thing. Firms read only average profit and take the riskier project. Splitting it among many shareholders shrinks the shakiness. The formulas below set the two yardsticks side by side. Everything here is risk, where the odds are known. For example, say a coin flip decides your 💰 allowance. Heads pays 10,000 won, tails pays nothing. The average is 5,000 won, yet you might prefer a sure 4,500. The 500 you give up out of caution is just like an insurance premium.
• When Uncertainty Becomes the Recession — In micro, uncertainty was one person's problem, shareable through insurance. In macro, when everyone is anxious at once, nobody is left to insure with. Fear of losing a 💼 job tomorrow closes wallets today. When everyone saves at once, 🏪 shop sales fall and the economy cools. Firms, fearing bad news, also postpone big investments. No average has gotten any worse. A recession can start from anxiety alone. For example, imagine all your classmates start saving their 💰 allowance. Each one is just bracing for a rainy day. But if nobody buys 🍬 candy, the shopkeeper orders less stock. Nothing bad has happened yet, and already the neighborhood has gone quiet.