Decision Making under Uncertainty

Consumers often face uncertainty when making significant financial decisions, such as purchasing a home, car, or investing in education. These decisions are influenced by unpredictable future income and the potential for rising costs over time.

Key aspects of this process involve quantifying risk through probabilities—either objective (based on data) or subjective (personal judgment)—to evaluate potential outcomes. Tools like expected value (the likely outcome) and variability (measuring risk levels through variance and standard deviation) help in assessing choices.

Uncertainty can be classified into risk (where probabilities are known) and ambiguity (where probabilities are unknown). Individuals’ preferences toward risk vary: they may be risk-averse (favoring certainty), risk-loving (preferring risk), or risk-neutral (indifferent).