The Economics of Uncertainty

Close by learning how to take the economic "stress test," inspired by bank evaluations made in the wake of the 2008 financial crisis. This simple exercise helps you anticipate the most significant reversals you are likely to meet, helping you approach uncertainty with confidence and calm.

Examine tools that professionals use to hedge against financial risk, such as forward contracts and financial options. Study the suitability of these instruments for individuals.

Look at possible catastrophes that are decades away: alarming trends such as overpopulation, scarcity of raw materials, and environmental degradation. Observe that society has so far escaped the worst predictions of experts, and explore why that is and what the future may really hold.

Free trade produces uncertainty and anxiety in economic players at all levels. Understand how comparative advantage governs who benefits in the competition for international trade.

Government policies are a major source of uncertainty, since they can alter our lives in unpredictable ways. Study the surprising outcomes from several government interventions in the U.

At any given moment, some market somewhere is making headlines because it's either hitting record highs or crashing down to earth. Learn how to approach the uncertainty of financial markets with savvy and common sense.

Even in times of low inflation, no one knows when prices will take off again. Look into the causes of inflation, efforts to control it, and the surprising wisdom of promoting a small degree of inflation.

Nothing is as certain and yet so unpredictable as the business cycle; economic expansion is invariably followed by a recession--and vice versa--but economists are at a loss to forecast the timing. Study different theories of the business cycle, and learn how to prepare for the next boom or bust.

Statistics are essential tools for dealing with uncertainty, but they should be used with caution. Put numbers such as the unemployment rate and consumer price index into context, probing how such statistics are measured and what the sampling error and confidence interval say about their reliability.

Investigate the multitude of ways you can insure against misfortune, from extended warranties to travel insurance to identity-theft protection--not to mention health, car, home, and life insurance. Learn how insurance products work, and get tips on what you should cover and at what value.

Altruism is more complicated than simple selflessness. Instead, it may be the world's oldest and most effective risk-sharing system.

Delve into the uncertain realm of compensation contracts, which ideally motivate employees to do a good job, but too often have unintended consequences. Survey the pluses and minuses of efficiency wages, piecework, milestone payments, commissions, promotions, stock options, and other incentives.

Focus on a special case of moral hazard: the principal-agent problem, in which an agent is appointed to handle a matter beyond the expertise of the person doing the hiring (the principal). The agent may easily take unfair advantage of this situation, which covers everything from home repair to government contracting.

Examine another outcome of asymmetric information: the moral hazard problem. This peril arose spectacularly in the 2008 financial crisis, with the widespread sale of bad loans to unwitting investors.

Adverse selection occurs when the lack of information by one party leads to a distorted result. See how this situation surfaces in many different contexts, from used car sales to investment deals to Internet purchases.

Use game theory to shed light on strategic interactions, which are competitive transactions involving people or organizations. Such interactions can range from negotiating the sale of a house to pricing products for maximum sales.

Gambling makes some people nervous, but it gives valuable insight into any type of risk-taking activity, including investing and entrepreneurship. Explore the role of games of skill and chance in the economy, and apply their lessons to activities such as banking and retirement planning.

When is a risky project worth doing? Learn how corporate managers decide whether they should undertake a new enterprise.

Having learned to convert uncertainty to risk in Lecture 2, now go deeper by investigating how probabilities can gauge rewards and risks. Test risk-assessing tools used in finance, including expected value, variance, standard deviation, coefficient of variation, Sharpe ratio, covariance, and beta.

Improve your ability to handle uncertainty by studying two ways that people reach decisions. System 1 excels at making snap judgments, while System 2 is analytical, methodical, and more time-consuming.

Examine two different types of probability. Frequency-based probabilities rely on many examples of a phenomenon, while subjective probabilities call on personal experience and judgment, often drawing on relatively few cases.

In dealing with uncertainty, it makes sense to have an arsenal of different strategies. Explore five techniques for risk management that can be used in every sphere of life: producing information, diversifying, sharing risk, avoiding risk, and absorbing risk.

When faced with an uncertain situation, try turning it into a "risky" situation. Risk is probability.

Professor Fullenkamp begins with "black swan" events--occurrences that are considered as improbable as black swans. A notable recent example is the 2008 financial crisis.