LectureVIII - Lecture VIII: Expected Utility Hypothesis...

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Lecture VIII: Expected Utility Hypothesis Basis for Applied Work I. From the Theory A. The von Nuemann-Morgenstern proof that consumers maximize expected income is based on basic tenants of consumer behavior. The proof was once harolded as a solid axiomatic proof near and dear to the hearts of mathematical economists. B. The expected utility maxim simply states that the consumer’s utility of a risky investment is equal to the expected utility of the possible outcomes: ( 29 ( 29 [ ] 1 ()() N ii i U EU w Uwfw dw or UwPw -∞ =  ==  = This maxim thus replaces an early belief that consumer’s maximize the expected value of the payoff: [ ] ( 29 [ ] 1 N i E w w fw dw or wPw -∞ = = = Notice that the older framework is a special case of the von Nuemann- Morgenstern framework {Risk Neutrality, or a linear utility function} C. Three attitudes toward risk: Notice that when we proved the linkage between lottery space and utility space we only required that the transformation U (.) be positive monotonic.
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LectureVIII - Lecture VIII: Expected Utility Hypothesis...

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