ABSTRACT
This chapter introduces economic decision-making under uncertainty and risk. We begin by defining actions, states of the world, and outcomes, and distinguish between objective and subjective probabilities, as well as between risk (known probabilities) and Knightian uncertainty (unknown or ambiguous probabilities). We explore how individuals evaluate risky choices using expected utility, emphasizing risk neutrality, risk aversion, and risk-loving preferences. Concepts such as mean-preserving spreads, concave and convex utility functions, and real options (where upside risk increases value) are illustrated. The chapter then outlines key strategies for managing risk: diversification, insurance, buffers (precautionary savings), and flexibility. Applications range from investment decisions and crop choice to firm capacity planning and gold mining. Tools introduced in this chapter help explain behaviors in finance, insurance, innovation, and enterprise, and form a conceptual bridge to advanced studies in microeconomics, decision theory, and behavioral economics.
