What does the term "expected utility" refer to in economics?

The term "expected utility" refers to the expected value of an individual's total utility, given uncertainty about future outcomes. This concept is central to understanding decision-making under risk, where individuals face uncertain future events that can affect their satisfaction or utility.

In economics, utility represents the satisfaction or pleasure derived from consuming goods and services. When individuals make choices that involve risk, such as investing in stocks or deciding to purchase insurance, they use the concept of expected utility to evaluate the potential outcomes of their decisions.

Expected utility is calculated by taking into account the probability of various possible outcomes and the utility associated with each outcome. For example, if a person considers a gamble where there is a chance of winning a high payoff or losing their investment, they would assess the expected utility by weighing the potential utility of winning against the probability of each outcome.

This concept helps explain why individuals might make choices that do not always align with pure profit maximization, as personal preferences and risk tolerance play significant roles in their decision-making processes. Thus, expected utility encompasses both the probabilities of potential outcomes and the values individuals assign to them, guiding rational choices under uncertainty.