Question

Explain why the expected utility criterion is not operational. Explain also why the criterion is still important.

Answer 1

Expected utility analysis relies on assigning an utility to an outcome based on the utility function of a particular person and the likelihood of that utility function which is denoted by the probablity. The basic assumption is that utility function and the probability distributions are independent from each other, however this may not be true because empirical evidence suggest a dependency. With this basic axiom violated, the efficacy of expected utility criterion is affected and not used in operations.

Even with this shortcoming, this theory helps people structure their decisions amidst uncertainty and the corresponding risk and also takes into account the inherent non-linear response of people to uncertain situations. This structured decision making helps people get valuable insights and take better decisions.