Subjective expected utility (SEU) theory, a cornerstone of behavioral economics, describes how individuals make decisions under uncertainty. It integrates four key concepts: utility, probability, expectation, and subjectivity. Utility quantifies the satisfaction or value derived from an outcome, while probability assesses the likelihood of its occurrence. Expectation represents the weighted average of possible outcomes based on their probabilities. Subjectivity captures the individual’s personal preferences and beliefs, which influence the utility values and probabilities they assign to outcomes.
The Structure of Subjective Expected Utility Psychology
Subjective expected utility (SEU) theory is a psychological theory that describes how people make decisions under uncertainty. It is based on the assumption that people choose the option that they believe will maximize their expected utility.
The SEU of an option is calculated by multiplying the probability of each possible outcome by the utility of that outcome, and then summing the products. For example, if you are considering buying a lottery ticket, you might assign a probability of 0.01 to winning the jackpot, a utility of 100 to winning the jackpot, a probability of 0.99 to not winning the jackpot, and a utility of 0 to not winning the jackpot. The SEU of buying the lottery ticket would then be:
SEU = (0.01 * 100) + (0.99 * 0) = 1
The SEU of an option can be used to compare different options and choose the one that is expected to maximize utility. However, the SEU of an option can also be used to assess the riskiness of an option. The riskier an option is, the more likely it is that the actual outcome will be different from the expected outcome. This can lead to a decrease in utility.
There are a number of factors that can affect the SEU of an option, including:
- The probability of each possible outcome. The more likely an outcome is, the greater its impact on the SEU.
- The utility of each possible outcome. The more desirable an outcome is, the greater its impact on the SEU.
- The riskiness of the option. The riskier an option is, the more likely it is that the actual outcome will be different from the expected outcome. This can lead to a decrease in utility.
The SEU of an option can be a useful tool for making decisions under uncertainty. However, it is important to keep in mind the factors that can affect the SEU and to consider the riskiness of an option before making a decision.
Structure of the SEU Model
The SEU model is composed of the following elements:
- A set of possible outcomes
- A probability distribution over the possible outcomes
- A utility function that maps each outcome to a value
The SEU of an option is calculated by multiplying the probability of each possible outcome by the utility of that outcome, and then summing the products.
Table of SEU Calculations
The following table shows the SEU calculations for the lottery ticket example:
| Outcome | Probability | Utility | SEU |
|---|---|---|---|
| Win the jackpot | 0.01 | 100 | 1 |
| Do not win the jackpot | 0.99 | 0 | 0 |
Question 1:
What is subjective expected utility psychology?
Answer:
Subjective expected utility psychology is a decision-making theory that predicts the decisions an individual will make under uncertainty. It suggests that individuals make decisions based on their subjective beliefs about the probability of different outcomes and the value they assign to each outcome.
Question 2:
How does subjective expected utility psychology differ from objective expected utility psychology?
Answer:
In objective expected utility psychology, the probability of outcomes and the values of outcomes are derived objectively, often based on historical data or expert opinion. In contrast, in subjective expected utility psychology, these probabilities and values are based on the individual’s own beliefs and preferences, which can be subjective and vary from person to person.
Question 3:
What are the limitations of subjective expected utility psychology?
Answer:
Subjective expected utility psychology assumes that individuals have well-defined preferences, can accurately estimate the probability of outcomes, and consider all relevant factors when making decisions. However, in reality, individuals may have inconsistent preferences, may overestimate or underestimate probabilities, and may not fully consider all factors, which can lead to deviations from the predicted decisions.
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