Question

Which would be the better option, according to utility theory?

a) Win $40 with the probability of 0.8, otherwise winning nothing
b) Win $30 with the probability of 1.00
c) they would be of the same value

Answer 1

According to utility theory, option a (win $40 with a probability of 0.8, otherwise winning nothing) would be the better option.

Step-by-step explanation:

According to utility theory, the better option is the one that provides greater expected utility. In this case, we need to calculate the expected utility for each option. Let's start with option a:

Expected utility of option a = (0.8 * utility of winning $40) + (0.2 * utility of winning nothing)

Expected utility of option a = (0.8 * 40) + (0.2 * 0) = 32 + 0 = 32

Next, let's calculate the expected utility for option b:

Expected utility of option b = (1.00 * utility of winning $30)

Expected utility of option b = 1.00 * 30 = 30

Comparing the expected utilities, we can see that option a has a higher expected utility of 32, while option b has an expected utility of 30. Therefore, option a would be the better choice according to utility theory.