Expected utility - consumer choice involving risk, Microeconomics

Expected Utility:

Theory Assume that a utility index exists which conforms to the five axioms. The expected utility for the two-outcome lottery L = (P, A, B) is given by, 

E [U (L)] = P U (A) +(1-P) U (B) 

Consider the lotteries L1 = (P1, A1, A2) and L2 = (P2, A3, A4). An expected utility theorem states that if L1 is preferred to L2, E [U (L1)] > E [U (L2)]. The significance of this theorem is that uncertain situations can be analysed in terms of the maximisation of expected utility. 

The proof of the theorem is straightforward. Select outcomes such that B, the best, is preferred to all other outcomes under consideration, and W, the worst, is inferior to all other outcomes. By the continuity axiom, Qi's exist such that Ai is indifferent to (Qi, B, W) (i=1,...,4). Thus L1 and L2 are equivalent to, i.e., have the same expected utility as, the lotteries (Z1, B, W) and (Z2, B, W) respectively where Z1 = P1Q1 + (1-P1)Q2 and Z2 = P2Q3 + (1-P2)Q4. By assumption, L1 is preferred to L2 and it follows from the unequal probability axiom that Z1>Z2. Since origin and unit of measure are arbitrary for utility indexes, let U (B) = 1 and U (W) = 0. Then E [U (L1)] = Z1 and E [U (L2)] = Z , establish the theorem.  

Posted Date: 10/26/2012 4:09:55 AM | Location : United States







Related Discussions:- Expected utility - consumer choice involving risk, Assignment Help, Ask Question on Expected utility - consumer choice involving risk, Get Answer, Expert's Help, Expected utility - consumer choice involving risk Discussions

Write discussion on Expected utility - consumer choice involving risk
Your posts are moderated
Related Questions
Q. Explain abput Capitalist Class? Capitalist Class:Group of individuals (which represents just a couple of percent of population in advanced capitalist countries) which contro

Dumping In the international marketing, when an organization charges less for goods than it real cost or less than the organizations charges in its home market. This procedure

use a graphical illustration to describe briefly what the influence of each of the following be on the market supply of labour,(a) an increase in immigrants, (b) a reduction in wag

The least square method is based on the assumption that the past rate of change of the variable under study will continue in the future. It is a mathematical procedure for fitting

electronic configuration of s block elements

Describe the poverty cycle and suggest how a developing country can break the cycle. The poverty cycle is explained as the trap developing countries can land in; low incomes →

What is the marginal opportunity producing the first unit of paper? The marginal opportunity cost of producing the forth unit of paper?

Normal 0 false false false EN-IN X-NONE X-NONE MicrosoftInternetExplorer4

As you know, Northern Nevada Green Coalition is interested in showing how green energy production can help to grow and diversify Nevada's economy. In order to do that, we need to a

During the 1990s, technological advance reduced the cost of computer chips. Explain, with the use of supply and demand diagrams, how the following markets are affected in terms of