Question #1fb09
1 Answer
- Risk is when the possible outcomes and their probabilities are known.
- Uncertainty is when we can't assess either the possible outcomes or their probabilities.
Explanation:
In economics, the distinction is made between "known unknowns", which can be modeled, and "unknown unknown", which can't.
In a game of roulette or when rolling a dice, there is risk involved but no uncertainty. When facing risk, outcomes and the probability distribution are known and it is possible to use them in economic decision making, e.g. when we're trying to minimize volatility or maximize expected returns.
Genuine uncertainty is when we know neither possible outcomes or their probabilities, making it hard or impossible to make rational economic decisions.
On a continuous scale between these two, there are also events of more ambiguous nature, such as elections and sport events, where the set of possible outcomes are well known, but their probabilities less so.
