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von Immanuel F.

What is “Expected Utility Theory” (EUT)?

Define it and explain its role in decision making under risk

EUT is a normative theory that suggests individuals make decisions by maximizing the expected utility rather than the expected value
Widely regarded as the gold standard for rational decision making under risk due to its flexibility in representing various preferences

Explain the structure of the St. Petersburg lottery and why it presents a paradox

In the St. Petersburg lottery, a player tosses a coin until tails appear; the payout doubles with each additional heads before tails.
The expected value of this lottery is infinite, but most individuals would not pay a high price to participate, illustrating a discrepancy between expected value and real decision-making behavior.

How is expected utility calculated for a basic lottery?