Decision-making in uncertain situations#
Topics#
Making decisions in uncertain situations, potentially involving multiple agents, can be challenging. Decision-making in uncertain situations involves uncertainty and risk. Thus, in this unit, we’ll introduce tools to model uncertainty, approaches to understand risk, and risk tolerance and model the actions of multiple actors involved in our decisions:
Expected utility hypothesis is a cornerstone concept in decision theory and economics. It proposes that individuals make choices based on their anticipated outcomes and corresponding utility or satisfaction. This hypothesis assumes that individuals are rational and seek to maximize their expected utility when making decisions, subject to various constraints.
Risk is the possibility of an adverse outcome or loss, typically resulting from uncertainty or exposure to danger. Risk aversion is the tendency of individuals or organizations to prefer a particular outcome over an uncertain one, even if the uncertain outcome has a potentially higher expected value. Understanding risk and risk aversion is crucial for making informed decisions that involve uncertainty and can help individuals and organizations manage and mitigate potential losses.
Multi-agent decision making involves situations where multiple agents or decision makers interact and influence each other’s choices. Game theory is a branch of mathematics that studies the strategic behavior of decision-makers in such situations. Game theory provides a framework for modeling and analyzing multi-agent decision-making, including how agents interact, what actions they might take, and how they choose among possible outcomes.
Assumptions#
This unit assumes a basic understanding of random variables and probability. Random variables are fundamental concepts in probability theory and statistics, representing numerical outcomes of uncertain events. They can be discrete, taking on only a finite or countable number of values, or continuous, taking on any value within a specific range. Probability theory is used to describe and analyze the likelihood of different outcomes of these random variables. For students uncomfortable with these topics, please consult the appendicies of these notes.