The Friedman–Savage utility function is the
utility function
As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosopher ...
postulated in the theory that
Milton Friedman
Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the ...
and
Leonard J. Savage
Leonard Jimmie Savage (born Leonard Ogashevitz; 20 November 1917 – 1 November 1971) was an American mathematician and statistician. Economist Milton Friedman said Savage was "one of the few people I have met whom I would unhesitatingly call a ge ...
put forth in their 1948 paper. They argued that the curvature of an individual's utility function differs based upon the amount of wealth the individual has. This variably curving utility function would thereby explain why an individual is
risk-loving
In accounting, finance, and economics, a risk-seeker or risk-lover is a person who has a preference ''for'' risk.
While most investors are considered risk ''averse'', one could view casino-goers as risk-seeking. A common example to explain risk-s ...
when he has more wealth (e.g., by playing the lottery) and
risk-averse
In economics and finance, risk aversion is the tendency of people to prefer outcomes with low uncertainty to those outcomes with high uncertainty, even if the average outcome of the latter is equal to or higher in monetary value than the more ce ...
when he is poorer (e.g., by buying insurance). The function has been used widely, including in the field of economic history to explain why social gambling did not necessarily mean that society had gone gambling mad.
Additions
Four years after the publishing of the original article,
Harry Markowitz
Harry Max Markowitz (born August 24, 1927) is an American economist who received the 1989 John von Neumann Theory Prize and the 1990 Nobel Memorial Prize in Economic Sciences.
Markowitz is a professor of finance at the Rady School of Management ...
, a former student of Friedman's, argued that some of the implications of the Friedman–Savage utility function were paradoxical.
Specifically, its implication that those at the highest level of income would never take risks. His solution was to relate the curvature of an individual's utility function to increases in wealth. This involved determining an individual's "normal" level of income, controlling for utility gains from "recreational investments" (The psychological utility gained by the act of gambling), and measuring deviations from the initial level of utility at the "normal" level of income.
See also
*
Expected utility hypothesis The expected utility hypothesis is a popular concept in economics that serves as a reference guide for decisions when the payoff is uncertain. The theory recommends which option rational individuals should choose in a complex situation, based on the ...
References
External links
Website discussing the theory
Milton Friedman
Utility function types
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