Redefining Utility in Terms of Gain-Loss Prospects

55 Pages Posted: 13 Jun 2017 Last revised: 4 Mar 2018

Date Written: June 11, 2017

Abstract

The author redefines utility in cardinal terms based on maximum willingness to pay. The proposed definition includes reference points for the agent’s income and needs, which is key to framing consumption in terms of gain-loss prospects. The proposed framework is robust because it resolves observed violations of standard consumer and decision theory. First, the author axiomatizes a new decision model and solves three puzzles – the Allais Paradox, the preference-reversal puzzle and the Ellsberg Paradox. Next, the author tackles the Endowment Effect, which stands for the gap between buying and selling prices. Finally, the author constructs a new intertemporal-choice model that is fully consistent with experimental evidence on utility discounting.

Keywords: Cardinal Utility, Prospect Theory, Allais Paradox, Preference-Reversal Puzzle, Ellsberg Paradox, Intertemporal Choice

JEL Classification: E03, E21, D03, D11, D90

Suggested Citation

Popov, Val, Redefining Utility in Terms of Gain-Loss Prospects (June 11, 2017). Available at SSRN: https://ssrn.com/abstract=2984550 or http://dx.doi.org/10.2139/ssrn.2984550

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