{"id":2580,"date":"2025-12-10T15:52:00","date_gmt":"2025-12-10T19:52:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=2580"},"modified":"2025-12-17T11:45:53","modified_gmt":"2025-12-17T15:45:53","slug":"expected-utility-theory","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/expected-utility-theory\/","title":{"rendered":"Expected Utility Theory: When It Works, and Where It Fails"},"content":{"rendered":"\n<p>How is the expected utility theory used to predict human behavior? Expected utility theory is a theory of how people make choices and take risks when they don&#8217;t know the outcome. <\/p>\n\n\n\n<p>Traditional expected utility theory asserts that people are rational agents that calculate the utility of each situation and make the optimum choice each time.&nbsp;We&#8217;ll look at how expected utility theory for <a href=\"https:\/\/www.shortform.com\/blog\/integrative-decision-making\/\">decision making<\/a> works and cover some of its flaws.<\/p>\n\n\n\n<!--more-->\n\n\n\n<p><em>Originally Published: November 1, 2019<\/em><br><em>Last Updated: December 10, 2025<\/em><\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-expected-utility-theory-assumes-people-are-perfectly-logical\"><strong>Expected Utility Theory Assumes People Are Perfectly Logical<\/strong><\/h2>\n\n\n\n<p>The traditional theory of <a href=\"https:\/\/www.shortform.com\/blog\/methods-of-decision-making-crucial-conversations\/\">decision-making<\/a>, known as <em>expected utility theory<\/em>, asserts that people rationally calculate how much they stand to gain or lose in each potential situation. Then, based on those calculations, they make the choice that\u2019s most likely to lead to the greatest personal benefit.&nbsp;<\/p>\n\n\n\n<p>However, people are <em>not <\/em>purely rational actors. Therefore, Kahneman argues that expected utility theory is not an effective way to explain people\u2019s actions.<\/p>\n\n\n\n<p>For example, suppose someone presents you with two options:&nbsp;<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>An 80% chance to win $100, with a 20% chance to win only $10&nbsp;<\/li>\n\n\n\n<li>A 100% chance to win $80&nbsp;<\/li>\n<\/ol>\n\n\n\n<p>If you calculate the average outcome of the first option based on probability, its <a href=\"https:\/\/www.shortform.com\/blog\/how-to-calculate-expected-value\/\">expected value<\/a> is greater ($82 versus $80). Therefore, according to utility theory, people should always choose it. However, Kahneman says <strong>most people will choose the second option because they prefer certainty over the chance to win more money.&nbsp;<\/strong><\/p>\n\n\n\n<figure class=\"wp-block-table\"><table class=\"has-fixed-layout\"><tbody><tr><td><strong>Expected Utility Vs. Expected Value<\/strong><br><br>Kahneman describes the flaws of expected utility theory at length, but it should be noted that this theory was, itself, a response to an even earlier theory called <em>expected value<\/em>.&nbsp;<br><br>Expected utility theory emerged as an answer to a <a href=\"https:\/\/www.shortform.com\/blog\/philosophical-thought-experiments\/\">thought experiment<\/a> called the <a href=\"http:\/\/www.econport.org\/econport\/request?page=man_ru_basics2\">St. Petersburg Paradox<\/a>: a game of chance where, in theory, you could win an infinite amount of money, but are much more likely to win very little. Expected <em>value <\/em>theory states that, since there\u2019s a chance of winning an infinite amount of money, it\u2019s rational to pay any amount of money to play. However, this is clearly flawed reasoning: Nobody would pay billions of dollars just for a miniscule chance of winning even more.&nbsp;<br><br>Expected utility theory tries to resolve the paradox by pointing out that, beyond a certain point, more money is not useful; therefore, even infinite money has finite <em>utility<\/em>. Now that there\u2019s a limit to the game\u2019s potential benefit, it makes rational sense to weigh that against how likely you are to lose money when you play, and decide how much a round of this game is actually worth to you.<\/td><\/tr><\/tbody><\/table><\/figure>\n","protected":false},"excerpt":{"rendered":"<p>How is the expected utility theory used to predict human behavior? Expected utility theory is a theory of how people make choices and take risks when they don&#8217;t know the outcome. Traditional expected utility theory asserts that people are rational agents that calculate the utility of each situation and make the optimum choice each time.&nbsp;We&#8217;ll look at how expected utility theory for decision making works and cover some of its flaws.<\/p>\n","protected":false},"author":14,"featured_media":2737,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[9],"tags":[55],"class_list":["post-2580","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-psychology","tag-thinking-fast-and-slow","","tg-column-two"],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v24.3 (Yoast SEO v24.3) - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Expected Utility Theory: When It Works, and Where It Fails - Shortform Books<\/title>\n<meta name=\"description\" content=\"Expected utility theory describes how people make choices and don&#039;t know the outcome. 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