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Expected Utility Theory - Lecture Slides

Lecture 8: Expected Utility Theory Alexander Wolitzky MIT 1 The Plan Course so far introduced basic Theory of choice and Utility , extended to consumer and producer Theory . Last topic extends in another direction: choice under uncertainty 2 Choice under Uncertainty All choices made under some kind of uncertainty. Sometimes useful to ignore uncertainty, focus on ultimate choices. Other times, must model uncertainty explicitly. Examples: Insurance markets. Financial markets. Game Theory . 3 Overview Impose extra assumptions on basic choice model of Lectures 1 2. Rather than choosing outcome directly, decision-maker chooses uncertain prospect (or lottery). A lottery is a probability distribution over outcomes.

Intuition: both having expected utility form and satisfying independence boil down to having straight, parallel indifference curves. 21. Subjective Expected Utility Theory. So far, probabilities are objective. In reality, uncertainty is usually subjective.

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