Utility Analysis
Utility analysis is a decision-making framework that evaluates choices by considering options, outcomes, and perspectives, quantifying subjective value under uncertainty.
THE IDEA
Utility Analysis
The owner of our infamous jar of jelly beans is selling people chances to win money by drawing a bean at random from the jar. You pay one dollar a chance, deciding beforehand which color bean you will try to pick. If you pick that color, you win a prize; if you don’t, you lose your dollar. The prizes vary as follows:
Red bean $2.00
Yellow bean $3.00
Green bean $4.00
I’ll refer to this example as I explain the three basic elements of utility analysis: options, outcomes, and perspectives.
When to use it
Deciding whether to purchase an extended warranty on a product.
Choosing between job offers with different salaries and risk profiles.
Making investment decisions under uncertainty, e.g., stocks vs. bonds.
Evaluating different health insurance plans with varying deductibles and coverage.
FROM THEORY TO EVERYDAY LIFE
In practice
Jelly Bean Lottery
You pay $1 to pick a colored bean. Red pays $2, Yellow $3, Green $4. Options (colors) and outcomes (prizes) are evaluated from different perspectives, such as risk tolerance or subjective value.
A MOMENT TO REFLECT
Put it to work.
How would your choice change if the prize for yellow was $10 instead of $3?
What perspective would lead you to choose a lower expected value but less risky option?
How does the concept of utility differ from expected monetary value in this scenario?
CONTINUE THE CONVERSATION
Source texts
- The Thinkers Toolkit by Morgan D Jones