Accounting for Tastes
Accounting for Tastes
This chapter explains the meaning of the payoffs that are used to quantify the outcomes of games. The theory of revealed preference assumes only that players are consistent. With appropriate consistency assumptions, it is shown that players act as though maximizing a utility function. The game of Russian Roulette is introduced to show that the players need to reveal preferences over lotteries so that risky situations can be accommodated. Von Neumann and Morgenstern's consistency postulates are shown to imply that an agent acts as though maximizing the expected value of a utility function in risky situations. Risk aversion is identified with having a concave Von Neumann and Morgenstern utility function. The properties of such functions are then explored. Russian Roulette is then analyzed to show that the outcome depends on the level of risk aversion of the players. Finally, Allais' paradox and Zeckhauser's paradox are used to comment on the difference between rational behavior in the presence of risk and actual behavior.
Keywords: payoff, revealed preference, rational choice theory, causal utility fallacy, Russian Roulette, Von Neumann and Morgenstern, risk, utility scales, interpersonal comparison, Allais' paradox
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