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The expected utility hypothesis imposes limitations on the utility function and makes utility cardinal (though still not comparable across individuals). Although the expected utility hypothesis is standard in economic modelling, it has been found to be violated in psychological experiments.
In this case, the expected utility of Lottery A is 14.4 (= .90(16) + .10(12)) and the expected utility of Lottery B is 14 (= .50(16) + .50(12)), so the person would prefer Lottery A. Expected utility theory implies that the same utilities could be used to predict the person's behavior in all possible lotteries.
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In economics, utility is a measure of a certain person's satisfaction from a certain state of the world. Over time, the term has been used with at least two meanings. In a normative context, utility refers to a goal or objective that we wish to maximize, i.e., an objective function.
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The mythological judgement of Paris required selecting from three incomparable alternatives (the goddesses shown).. Decision theory or the theory of rational choice is a branch of probability, economics, and analytic philosophy that uses the tools of expected utility and probability to model how individuals would behave rationally under uncertainty.
The rank-dependent expected utility model (originally called anticipated utility) is a generalized expected utility model of choice under uncertainty, designed to explain the behaviour observed in the Allais paradox, as well as for the observation that many people both purchase lottery tickets (implying risk-loving preferences) and insure against losses (implying risk aversion).
However, that the same person (who chose 1A alone or 2B alone) would choose both 1A and 2B together is inconsistent with expected utility theory. [4] According to expected utility theory, the person should choose either 1A and 2A or 1B and 2B. Expected payouts (in millions) are 1.11 for 1A+2A combination, 1.89 for 1B+2B combination, 1.50 for 1A ...