SUBJECTIVE

EXPECTED UTILITY
MODEL
- Elements of decision under uncertainty

INTRODUCTION
Proposed by Savage in 1954.
The subjective expected utility (SEU) model provides
the conceptual and computational framework that is
most often used to analyze decisions under uncertainty.
Uncertainty about the future is represented by a set of
states of the world, which are mutually exclusive and
exhaustive events.
Possible outcomes for the decision maker are
represented by a set of consequences.

INTRODUCTION CNTD.
Two essential characteristics:
1.

A choice must be made among various possible

courses of actions.
2. This choice or sequence of choices will ultimately
lead to some consequence, but DM cannot be
sure in advance what this consequence will be,
because it depends not only on his or her choice
or choices but on an unpredictable event.

WHEN CAN UNCERTAINITIES

OCCUR?
When DM are clear about range of possible events but
uncertain about which will occur.
When DM are uncertain about the important factors.
Quantitative analysis- judgmental, theoretical considerations,

DEMONSTRATION OF SEU
MODEL
EXAMPLE:
You are home, and you must decide how to get to
class on a nice spring day. The classroom is five miles away,
and you have an hour to get there.
How to take decision based on SEU Model?

DEMONSTRATION OF SEU
MODEL CNTD.
Based on SEU Model we can take following steps:

List all feasible options : Walk, bus, bicycle or drive

Enumerate all possible consequences of each options/actions.
Assess utility of each option.
Evaluate the probability that the consequences of each option will actually occur.
Compute the expected utility, or "EU," of each option.
Choose the outcome with the greatest EU.

On Time

Exercise

Means

(Prob X

Utility)

Plus

(Prob X

Utility)

Equals

EU

Walk

(1 X

9)

Plus

(6 X

9)

Equals

63

Bus

(9 X

9)

Plus

(2 X

9)

Equals

99

Bicycle

(8 X

9)

Plus

(8 X

6)

Equals

120

Drive

(5 X

9)

Plus

(1 X

9)

Equals

54

ROLE/BENEFITS OF SEU IN
DECISION MAKING
Optimizes the decisions.
Provides mathematical foundation for a broad range of social
and economic theories
Helps the economists to take decisions in uncertain
environments- asset allocation, insurance, saving,
investment.
Applicable to any decision.
Key features of insurance and financial markets can be
better explained by SEU model.
Led to establishment of game theory as a foundation for
microeconomics.

CRITICISM OF SEU
It assumes that decision making is in some sense
"compensatory.
Scientists have criticized the model because they are not
sure that it accurately reveals the steps that people take as
they make decisions.
Use of the SEU model implies that people act as if they had
calculated the "expected utility" of each option, however, it
has been seen that most of the times, individuals often do
not behave in a manner consistent with these models.

THANK YOU