Lesson 5 - Utility & Decision Making

Question 1

When do you use Utility in decision making?

Answer 1

When expected monetary value approach does not lead to the most preferred decision alternative, use utility to arrive at a decision.

Question 2

Utility

Answer 2

A measure of the total worth of an outcome. It reflects decision maker’s attitude towards profit, loss, and risk.

*Utility is a useful measure of how an individual decision maker views the value to him of an alternative at a given point in time. This same individual may have a

Question 3

When expected payoffs become extreme…

Answer 3

most decision makers are not comfortable with the decision that simply provides highest monetary expected value.

Question 4

Expected Utility

Answer 4

Provides a tool that the decision maker can use in any situation where risk is an important consideration.

Question 5

If decision involves considerable risk…

Answer 5

Best tool to use is Expected Utility concept, otherwise, Expected value approach is a more useful tool.

Question 6

Risk Avoider

Answer 6

Graph: Curve is convex –> it bends down at the top.

Utility function for a risk avoider shows a diminishing marginal return

Question 7

Risk Taker

Answer 7

Graph: Curve is concave –> it bends upwards at an increasing rate.

Utility function of a risk taker shows an increasing marginal return for money.