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Expected Utility Criteria

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In Problem 3-28, you helped the medical professionals analyze their decision using expected monetary value as the decision criterion. This group has also assessed their utility for money: U(-$45,000) = 0, U(-$40,000) = 0.1, U(-$5,000) = 0.7, U($0) = 0.9, U($95,000) = 0.99, and U($100,000) = 1. Use expected utility as the decision criterion, and determine the best decision for the medical professionals. Are the medical professionals risk seekers or risk avoiders?

3-28 for reference only:
A group of medical professionals is considering the construction of a private clinic. If the medical demand is high (i.e., there is favorable market for the clinic), the physicians could realize a net profit of $100,000. If the market is not favorable, they could lose $40,000. Of course, they don't have to proceed at all, in which case there is no cost. In the absence of any market data, the best the physicians can guess is that there is a 50-50 chance the clinic will be successful. Construct a decision tree to help analyze this problem. What should the medical professionals do?)

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Solution describes the steps and calculations to check whether medical professionals risk are seekers or risk avoiders.

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Solution:

Probability (Favorable Market)=0.5
U(payoff under favorable market)=U($100,000)=1
Probability (Unfavorable Market)=0.5
U(payoff under unfavorable market)=U(-40000)=0.1 ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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