Decisions Involving Uncertainty

Fair bet

A gamble that, on average, will leave you with the same amount of money

Utility

Measure of wellbeing

Marginal utility

Utility from one more $1 in wealth

Diminishing marginal utility

Each additional dollar/good adds less to utility than the previous dollar/good

Expected utility

- What your utility will be on average if you make a particular choice

- Expected utility = (Probability business succeeds × Utility if business succeeds)+ (Probability business fails × Utility if business fails)

5 strategies for reducing risk

1. Risk spreading

2. Diversification

3. Hedging

4. Insurance

5. Information gathering

Availability bias

Items that are more readily available in memory are judged as having occurred more frequently (sharks are dangerous)

Anchoring bias

A tendency to fixate on initial information, from which one then fails to adequately adjust for subsequent information

Representativeness bias

Assess how likely it is something belongs in a category by judging how similar they are to that category (ex: white male CEO)

Focusing illusion

The tendency to overestimate the effect of a single factor on one's life satisfaction

Loss aversion

More sensitive to loss than gain