Econ 100A: Choice Under Uncertainty; Choice Over Time

These flashcards cover key terms and concepts from the lecture on choice under uncertainty and choice over time in economics.

Uncertainty

The state of being uncertain; a situation where the outcomes of actions are unpredictable.

Expected Utility

A decision-making framework that evaluates choices based on their expected outcomes.

Risk Aversion

The tendency to prefer outcomes with lower uncertainty when presented with risky options.

St. Petersburg Paradox

A problem in probability and decision theory highlighting discrepancies between expected utility and actual decisions.

Lottery

A game of chance where participants select possibilities and outcomes are determined randomly.

Continuity Axiom

The principle that small changes in probabilities should not alter preference order between lotteries.

vNM Utility Function

Von Neumann-Morgenstern utility function representing preferences in uncertain situations.

Independence Axiom

A principle stating that if a decision-maker prefers one lottery to another, they should also prefer compound lotteries where each contains those lotteries.

Expected Value

The average value of outcomes weighted by their probabilities.

Compound Lottery

A lottery that involves other lotteries as its outcomes.

Decision-maker (DM)

The individual making choices under uncertainty.

Lexicographic Preferences

Preferences where one outcome is always preferred over another regardless of the probabilities of their occurrence.

Utility

A measure of satisfaction or value derived from an outcome.

Certainty Equivalent

The guaranteed amount of money that a decision-maker would accept instead of taking a gamble.

Probability Premium

The extra likelihood needed for an individual to remain indifferent between a certain outcome and a gamble.

Diminishing Marginal Utility

The principle that as a person consumes more of a good, the additional satisfaction gained from consuming an additional unit decreases.

Discounted Utility Model

A model that assesses the value of future utilities based on the present value adjusted by a discount rate.

Stationarity

The assumption that preferences or utilities do not change over time.

Absolute Risk Aversion

A measure of how much risk averse an individual is, regardless of wealth levels.

Relative Risk Aversion

A measure of how risk aversion changes with levels of wealth.

Allais Paradox

A demonstration of how people's choices can violate expected utility theory due to inconsistencies in risk preferences.

Ellsberg Paradox

A situation demonstrating the preference for known risks over unknown risks.

Kahneman and Tversky

Psychologists known for their work on behavioral economics and decision-making under uncertainty.

Commitment Devices

Strategies used to lock oneself into more optimal choices for future decisions.

Procrastination

The action of delaying or postponing tasks, often linked to time inconsistency.

Behavioral Economics

A field that studies the effects of psychological, cognitive, emotional, cultural, and social factors on economic decisions.

Temporal Discounting

The reduction of perceived value of future rewards in comparison to immediate rewards.

Choice Over Time

The process of evaluating options that yield different outcomes at various future times.

Nudges

Subtle policy shifts that encourage people to make decisions that are in their broad self-interest.

Financial Innovation

Improvements in financial products that may influence saving behavior and consumer options.

Time Inconsistency

A preference reversal where present preferences differ from future preferences.

Opportunity Cost

The potential benefit lost by choosing one alternative over another.

Marginal Utility

The additional satisfaction or utility gained from consuming one more unit of a good.

Regret Theory

The idea that individuals anticipate regret when making a decision and may act to avoid it.

Decision Weights

The subjective probabilities assigned by individuals to uncertain outcomes.

Preference Reversals

A phenomenon where preferences change based on the framing of choices.

Ambiguity Aversion

A preference for known risks over unknown risks.

Time Preference

An individual's relative valuation of payoffs at different points in time.

Utility Maximization

The process of choosing the option that provides the highest level of satisfaction.

Discount Rate

The interest rate used in discounting future cash flows.

Geometric Series

A series of numbers where each term after the first is found by multiplying the previous one by a constant.

Indifference Curve

A graph that shows the combination of two goods that provide the same level of utility.

Savings Behavior

The tendency of individuals to save money based on their preferences and future expectations.

Behavioral Anomalies

Patterns of behavior that deviate from standard economic theory predictions.

Cognitive Dissonance

A mental discomfort that arises from holding two conflicting beliefs or values.

Risky Choice Framing

The manner in which choices are presented can affect decision outcomes.

Utilitarian Perspective

An ethical theory that advocates for actions that maximize happiness or well-being.

Tversky’s Value Function

A function that describes how people experience gains and losses, reflecting loss aversion.

Subjective Expected Utility

An extension of expected utility theory that incorporates personal beliefs about probabilities.

Practical Applications of EU

Real-world implications and methods for applying expected utility theory.

Weak Order Preferences

Preferences that can be weakly ordered; an outcome can be indifferent to another.

Framing Effects

The influence of the presentation of information on decision-making.