Game Theory & Decision

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Expected Utility

Weighted average of the utility of outcomes, not just their cash value.

Formula

EU = \sum_i p_i u(x_i)

Variables

EUExpected utility

p_iProbability i

u(x_i)Utility of outcome i

Example

Diminishing utility explains why people buy insurance despite negative EV.

Did You Know?

Expected utility, formalised by von Neumann and Morgenstern in 1944, explains risk-averse behaviour.

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