Risky Choices

Abstract

An important step in the development of rational choice theory is the introduction of incomplete information. This means that rational choice theory can also account for decisions under conditions of risk. In this kind of situations the range of possible outcomes of decisions is known, but it is unknown which outcome will be realized.¹ Agents, therefore, combine ‘pure’ outcomes with probabilities. For these kind of situations ‘expected utility theory’ has been developed. The central idea of this theory is that whenever one is uncertain about the outcomes of actions, the choice process can be described in terms of the participation in a lottery with the (expected) outcomes as prizes. A rational actor will estimate the expected utility of each action alternative by multiplying (the utility of) outcomes and probabilities and then he will chose in such a way that average expected utility is maximized.