Decision Theory Vocabulary

the weighted average of utilities across possible outcomes

“Rational agents maximize expected utility.”

Origin: From expected + utility (Latin utilitas `usefulness`)

preference for certainty over gambles with equal expected value

“Risk aversion explains why people buy insurance.”

Origin: From risk + aversion (Latin aversio `turning away`)

indifference between certain outcomes and gambles of equal expected value

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

Origin: From risk + neutral (Latin neutralis `of neuter gender`)

a past cost that cannot be recovered

“Rational decisions should ignore sunk costs.”

Origin: From sunk (past participle of sink) + cost

the value of the best alternative forgone

“The opportunity cost of college includes lost wages.”

Origin: From opportunity (Latin opportunitas) + cost

the additional satisfaction from consuming one more unit

“Marginal utility typically decreases with consumption.”

Origin: From marginal (Latin margo `edge`) + utility

decreasing incremental output as input increases

“Adding more workers eventually yields diminishing returns.”

Origin: From diminish (Latin diminuere `to lessen`) + returns

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

“A perfectly competitive market reaches Pareto optimality.”

Origin: Named after Vilfredo Pareto, Italian economist (1848-1923)

inferring preferences from observed choices

“Revealed preference shows she values time over money.”

Origin: From reveal (Latin revelare) + preference

the relative valuation of present versus future consumption

“High time preference leads to lower savings rates.”

Origin: From time + preference (Latin praeferre `to put before`)