What is expected utility maximization?

The expected utility hypothesis is a foundational economic and decision-theory assumption stating that rational agents make decisions under uncertainty by maximizing their subjective desirability of payoffs. It posits that an agent chooses between risky prospects by comparing the weighted sum of utility values multiplied by their respective probabilities. While central to mathematical economics and rational choice theory, it often clashes with the empirical findings of experimental psychology.

What we know

• The expected utility hypothesis postulates that rational agents maximize utility, which is the subjective desirability of their actions under uncertainty. [2]
• An agent evaluates risky prospects by calculating the weighted sum of the utility values of payoffs multiplied by their probabilities. [2]
• The von Neumann-Morgenstern utility theorem proves that individuals satisfying four specific axioms will always prefer actions that maximize expected utility. [3]
• The hypothesis converts standard ordinal preferences into a cardinal utility function, where the curvature of the utility function represents an agent's risk attitude. [2]

Still open

• The expected utility hypothesis is frequently found to be inconsistent with empirical results from experimental psychology, leading researchers to develop alternative frameworks like prospect theory.

Where to go next

• compared withWhat is prospect theory?
• whoWho are John von Neumann and Oskar Morgenstern?
• the bigger pictureHow does rational choice theory model human behavior?
• how it workedWhat is decision theory?
• how we knowHow do psychological experiments challenge economic models?
• an unexpected connectionHow does utilitarian philosophy connect to modern microeconomics?The decision utility used to model mathematical choices under uncertainty traces its conceptual lineage directly back to the moral philosophy of Jeremy Bentham and John Stuart Mill.

Sources

• [1]expected utility hypothesis (Wikidata Q2319304) · CC0 1.0
• [2]Expected utility hypothesis · CC BY-SA 4.0
• [3]Von Neumann–Morgenstern utility theorem · CC BY-SA 4.0
• [4]Utility · CC BY-SA 4.0
• [5]Decision theory · CC BY-SA 4.0