Expected Utility Definition
Expected utility refers to the usefulness, profitability, or utility that an economy is anticipated to accumulate under given circumstances within a space of time. As a term in economics, the expected utility also describes the anticipated value (utility) an action should produce under certain situations.
Expected utility is also used as a decision theory to describe the decisions individuals are expected to make under given circumstances, especially in uncertain situations. This theory analysis uncertain situations with a bid to identify decisions that can be made in those situations and the possible outcomes of the decisions.
A Little More on What is Expected Utility
According to the expected utility hypotheses, individuals have preferences relating to choices that can be made in uncertain conditions. Each of the choices will have outcomes and these outcomes and the probability of an event occurring are considered under the expected utility.
To calculate the expected utility, the weighted average of all the possible outcomes under given circumstances will be weighed against the probability of an event occurring. The expected utility theory becomes significant in situations that warrant decisions to be made by individuals, especially when they have no idea of the outcomes of the decisions made.
History of the Expected Utility Concept
The expected utility theory was first used by Daniel Bernoulli who used it to solve a complex scenario in the St. Petersburg Paradox. This St. Petersburg Paradox is purely a game of chances where players make decisions as to where to toss their coins without having an idea of what the outcome of their decisions would be.
As used by Danial Bernoulli who sought to draw a clear line between the expected value and expected utility, calculating the expected utility has to do with factoring the weighted utility and multiply them by the probabilities of the outcomes.