Decision Theory Vocabulary

the weighted average of utilities across possible outcomes

“Rational agents maximize expected utility.”

preference for certainty over gambles with equal expected value

“Risk aversion explains why people buy insurance.”

indifference between certain outcomes and gambles of equal expected value

“Corporations often behave as risk neutral for small bets.”

a past cost that cannot be recovered

“Rational decisions should ignore sunk costs.”

the value of the best alternative forgone

“The opportunity cost of college includes lost wages.”

the additional satisfaction from consuming one more unit

“Marginal utility typically decreases with consumption.”

decreasing incremental output as input increases

“Adding more workers eventually yields diminishing returns.”

a state where no one can be made better off without making another worse off

“A perfectly competitive market reaches Pareto optimality.”

inferring preferences from observed choices

“Revealed preference shows she values time over money.”

the relative valuation of present versus future consumption

“High time preference leads to lower savings rates.”