Decision Making and Utility Theory Concepts

What does the cost-benefit approach of decision making suggest?

If the benefit of undertaking an activity exceeds its costs, undertake that activity.

What are utility functions a function of?

Wealth, not wages, and they increase at a decreasing rate.

According to Von Neumann and Morgenstern's utility index, what is the goal of decision making?

Decisions are made to maximize expected utility.

How is expected utility calculated?

By multiplying the probability of the outcome by the utility of the resulting wealth.

What are the classifications of decision-makers under utility theory?

Risk-adverse, risk-seeking, and risk-neutral.

What are non-recoverable sunk costs?

Costs that are beyond recovery and should be ignored in the decision calculation.

What do marginal costs and benefits measure?

They measure activity incrementally and help determine the level at which activity stops.

What is opportunity cost?

The value of all that must be sacrificed in order to benefit.

What describes a risk-averse person?

A person who is willing to accept a small cash-certain amount rather than the expected value of a bet.

What is the general classification of most organizations regarding risk?

Most organizations are risk neutral.

What does the certainty equivalent represent?

How much you are willing to sacrifice from your certain amount to avoid a gamble.

What do utility functions depict?

The subjective attitude toward risk of the decision maker.

What is marginal benefit?

The increase in total benefit that results from carrying out one additional unit of an activity.

Which concepts are part of the cost-benefit method of decision making?

Opportunity cost, sunk costs, and marginal cost/benefits.

What claim does Utility Henry make about decision making?

Decisions are made to maximize expected utility rather than expected monetary value.

What is the purpose of the utility index proposed by Von Neumann and Morgenstern?

It is designed for predictive purposes and enables decision making based on preferences in situations where risk exists.