Week 3 - Decision Making - Week 3 - Decision Making - Dr...

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Week 3 - Decision Making - Dr Ken Manktelow SEU = Subjective Expected Utility - Normative theory of decision making. - Economists assume this is being done frequently. - Decisions are regarded as gambles: utility x probability - Person’s goal: maximise SEU - Previous example: Millionaire contestants think about how much they could win or lose, and how likely it is. - SEU = (Sigma sign)ipiUi - which means: take each outcome (i), multiply its untility (U) by its probability(p), and add them all up (sigma sign). - 'Utility' is not the same as pleasure: it means something that has value (not a financial value) to you, i.e. that helps you attain a goal. - Example: dice rolls. Win on doubles: £2 for 2-2, 3-3, 4-4, 5-5; £5 for 6-6: £10 for 1-1 - The probability (p) of each win is its chance of occuring. Its utility (U) is its money value. - p(2+2) = 0.028 - U(2+2) = £2 - EU (2+2) = 0.028 x £2 = £0.056; - Same for 3+3, 4+4, 5+5. - p(6+6) = £0.14 - p(1+1) = £0.28 - SEU of 2-2 is 1/36 x £2 = .028 x £2 = £0.056. Add them all up. Total SEU = £0.644 Logical consequences of this view: - Weak ordering - There will be some kind of order of preferences between outcomes. - Independence - Factors common to all options should not affect choice.
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Week 3 - Decision Making - Week 3 - Decision Making - Dr...

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