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Sunil Simon
Elements of a decision problem/game
Actions (A) – alternatives from which an agent/player can choose.
Outcomes (X) – possible consequences that can result from the actions of each
player.
Preference relation
Weak preference relation: x ⪰ y – x is at least as good as y.
x ≻ y iff x ⪰ y and y ⪰
/x
x ≈ y iff x ⪰ y and y ⪰ x
Proposition. If the set of outcomes X is finite then any rational preference relation
over X can be represented by a utility function.
Proof. Since the preference relation is complete and transitive, find a least preferred
outcome x1 ∈ X such that all other outcomes y ∈ X, y ⪰ x1 .
Continue until the best outcome equivalence set Xn is created. Since X is finite and ⪰
is rational such a finite collection of equivalence sets exists.
Choose n arbitrary values un > un−1 > . . . > u1 and let u(x) = uk for x ∈ Xk .
(v ○ u)(x) = v(u(x))
Lottery
Lotteries over X is L = {[p1 (x1 ), . . . , pk (xk )] ∣ pi ≥ 0 and p1 + p2 + . . . + pk = 1}.
Example
Observation. The set of outcomes X can be regarded as a subset of the set of lotteries
L.
Utility function
A utility function u represents the preference relation ⪰ if for any pair of lotteries L, L′
we have u(L) ≥ u(L′ ) iff L ⪰ L′ .
Compound lottery
L̂ = [q1 (L1 ), q2 (L2 ), . . . , qm (Lm )].
Utility function
A utility function u ∶ L̂ → R represents the preference relation ⪰ if for any pair of
compound lotteries L̂, L̂′ we have u(L̂) ≥ u(L̂′ ) iff L̂ ⪰ L̂′ .
Axiom 3 – Simplification. Let L̂ = [q1 (L1 ), q2 (L2 ), . . . , qm (Lm )] and for each
j j j
j ∶ 1 ≤ j ≤ m let Lj = [p1 (x1 ), p2 (x2 ), . . . , pk (xk )].
Consider the simple lottery L = [r1 (x1 ), r2 (x2 ), . . . , rk (xk )], then L̂ ≈ L.
Example
L = [ 12 (x1 ), 14 (x2 ), 18 (x5 ), 18 (x7 )]
L1 = [ 23 (x1 ), 13 (x2 )]
L2 = [ 12 (x5 ), 12 (x7 )]
L̂ = [ 34 (L1 ), 14 (L2 )]
Theorem. If the preference relation ⪰ over L̂ is complete, transitive and satisfies the
four von Neumann-Morgenstern axioms then ⪰ can be represented by a linear utility
function.
u(L̂) = r1 θ1 + r2 θ2 + . . . + rk θk .
For every simple lottery L = [p1 (x1 ), . . . , pk (xk )], u(L) = ∑kj=1 pj θj
Outcome xj is same as the lottery L = [1(xj )] which is same as L̂ = [1(L)]. So
outcome of L̂ is xj with probability 1. So we have
⎧
⎪
⎪1 if i = j,
ri = ⎨
⎪
⎩0 if i ≠ j.
⎪
Need to show that for each simple lottery L = [p1 (x1 ), . . . , pk (xk )],
k
u(L) = ∑ pj u(xj )
j=1
We have,
1 u(L) = ∑kj=1 pj θj ,
2 u(xj ) = θj .
(1) implies that u(L) = ∑kj=1 pj θj and (2) implies that ∑kj=1 pj u(xj ) = ∑kj=1 pj θj .
Need to show that for any pair of compound lotteries L̂ and L̂′ ,
Proof. Let L̂ = [q1 (L1 ), q2 (L2 ), . . . , qm (Lm )] and for each j ∶ 1 ≤ j ≤ m let
j j j
Lj = [p1 (x1 ), p2 (x2 ), . . . , pk (xk )].
Let ri = q1 pi + q2 pi + . . . + qm pm
1 2
i (the probability that the outcome is xi in L̂).
k
r∗ = ∑ ri θi = u(L̂).
i=1