Expected utility theory

Question 1

4 preference assumptions

Answer 1

1. Completeness - You like one better than the other or equally as much
2. Transivity (If X>Y and Y>Z then X>Z …)
3. Monotonicity - More is good
4. Convexity for indifference curves - The averages of consumption bundles are preferred to extremes - In a concave indifference curve, the extreme points are preferred

Question 2

Ordinal v cardinal statement

Answer 2

Ordinal = Relative
Cardinal = Empirical

Question 3

Probability is calculated based on…

Answer 3

1. Frequency
2. Subjective probability - Based on Tripadvisor
3. Probability distribution - Probability of occurence of each mutually exclusive outcomes

Question 4

Expected value formula

Answer 4

(Pr1 * V1) + (Pr2*V2)

Question 5

Standard deviation

Answer 5

The smaller the variance, the smaller the standard deviation, the smaller the risk

Question 6

Expected utility formula

Answer 6

{Pr1U(V1)} + {Pr2U(V2)}

Question 7

Fair bet

Answer 7

1. Has an expected value of 0
2. Risk aversive does not like it
3. Risk preferring likes it
4. Indifferent is indifferent

Question 8

Expected utility graph

Answer 8

1. Expected utility on the graph is the midpoint between the two possible outcomes
2. For risk aversive - The price to pay to avoid the bet is the difference between the two expected values

Question 9

Human cognitive process

Answer 9

1. Sensory input sent to working memory
2. Working memory transfers info to central executive using phonological loop and visuospatial sketchpad
3. Eventually transferred to LTM (both procedural and declarative)

Question 10

Heuristics in decision-making are due to…

Answer 10

1. Bounded rationality
2. Automatic association
3. Availability heuristic

Question 11

Criterion for rational choice

Answer 11

1. Based on current assets
2. Based on possible consequences
3. If uncertain consequences, likelihood is evaluated using basic rules of probability theory
4. Choice is adaptive if the above conditions change
5. Departures can be due to habit, conformity and religious/moral/cultural principles

Question 12

Modern utility theory

Answer 12

Redefines utility on personal value, as opposed to monetary value