3.2 Utility theory

Utility theory is based on this assumption of rationality and describes all decision outcomes (financial and otherwise) in terms of the utility (or value) placed on them by individuals. Within this framework, decisions can be understood in terms of rationally ordered levels of utility attached to different outcomes.

Bazerman (2001, pp.3–4), for example, describes a formally rational decision process for arriving at a decision with the greatest expected utility in the following terms:

• define the problem

• identify the decision criteria

• weight the criteria

• generate alternatives

• rate each alternative on each criterion

• compute the optimal decision.

More sophisticated versions of such decision processes allow for the calculation of probabilities for different possible outcomes associated with each alternative and the weighting of the utility of those outcomes by their probability. Indeed, the discipline of decision sciences is devoted to the study and development of such analytical and model-building methods to support formally rational decision making. We could not possibly do justice to a field as broad as decision sciences within the scope of this course. However, for a good introduction see Wisniewski (2000).