Expected utility is defined as what?

• A. Maximum utility for wealth
• B. Minimum risk in investments
• C. Probability weighted average of utility across outcomes
• D. Total return on investments

Answer: (C)

Expected utility is fundamentally rooted in decision theory and helps to evaluate choices under uncertainty, particularly in the context of investment decisions. The concept refers to a calculation where the various outcomes of a decision are weighted by their probabilities, yielding a singular measurement of anticipated satisfaction or value.

When assessing expected utility, one takes into account multiple potential results from a particular investment or decision, each associated with a specific likelihood of occurrence. By multiplying the utility associated with each outcome by the probability of that outcome happening and then summing these products, investors can derive an overall expected utility figure.

This notion aligns with how investors approach risk and reward. It recognizes that individuals often seek to maximize their expected satisfaction rather than mere monetary gain, embodying the rational decision-making process amidst uncertainty. Thus, the correct answer captures the essence of expected utility by emphasizing the probability-weighted average of utility across various outcomes.