Max(Utility) from Variety & Taste

If a decision process is designed according to the classical utility maximization model, then the choice of an option is explained by it having the highest utility among considered options. Consequently, decision governance over such a decision process needs to influence (i) which options are considered, (ii) how options are compared against preferences, and (iii) how preferences are formed.

This text is part of the series on the design of decision governance. Decision governance are guidelines, rules, processes designed to improve how people make decisions. It can help ensure that the right information is used, that that information is correctly analyzed, that participants in decision making understand it, and that they use it before they make a decision. Find all texts on decision governance here.

What is the topic of this text?

If a decision process is designed according to the classical utility maximization model, then, one, How does it explain decisions? and two, How to influence that process through governance?

Why is this topic relevant for decision governance?

The classical utility maximization model is widely used in education in economics. It is the basic model of decision making in microeconomics, and the simplest model capturing the idea that the option to select is the option which is most desirable among those considered. Utility is the name given to the measure of desirability.

The reason the classical utility maximization model is interesting for decision governance is that it is common to require through decision governance that options are identified and described, that criteria are defined, and options compared against criteria; this is usually followed by the calculation of a single number for each option, as a synthesis of all information about how the option ranks against various criteria. That single number, when without a unit, is called utility. Sometimes, a decision process may not explicitly use utility as a measure, but have one metric it ultimately compares options over, such as, for example the net present value in a currency of interest (in which case the NPV is a proxy for utility).

If you understand how a decision is explained using the classical utility maximization model , then you know the factors which determine the decision. This allows you to design decision governance which influences these factors, to steer decision making to better options.

Background: What is the classical utility maximization model?

In the classical utility maximization model, we have the following:

One decision maker
Options that the decision maker chooses from
Criteria that the decision maker uses to compare options
Preferences that the decision maker has over each criterion
Relative importance that criteria have for the decision maker
The assumption that the decision maker will choose the most desirable option, whereby desirability takes into account preferences and importance of criteria

(Note that the model can be described in different ways, including as a problem of choosing between combinations of goods, or quantities of goods under a budget constraint. The version I’m using here is the expected utility model that ignores uncertainty, because this version is more common in my experience; I have seen many business cases, for example, which are structured in terms of options, criteria, ranking over criteria to reflect preference, relative importance of criteria, and then, a single rank which aggregates preference and criteria importance.)

It is important to understand the differences and relationships between concepts of criteria, preferences, and criterion importance:

A criterion is something that we use to compare options. Generally speaking, it is a variable we use to describe all options, such that each option can be given a value for that variable, and different values influence desirability differently. Color, weight, length, width, and so on can be such variables, but they will also be criteria only if the desirability of an option over another depends on the differences over that variable: color will be a criterion if it matters to me which color is associated with each option, and vice versa if I’m not indifferent to color of options. Criteria can be as simple as those I mentioned, but they can be more complex, i.e., it may be unclear what values they can have, and how these values are mapped to options. For example, the aesthetic preference of judges in a competition for architectural designs or best films.
A preference is a relation over values of a criterion that reflects the relative desirability of these values. If I am choosing a car and I am considering only cars that are red, white, or black, then my preference for car color needs to say how I relate the three colors in terms of which is more desirable than the other; for example, I prefer red to black, black to white, and red to white.
You can see by now that if you have more than one criterion when comparing options, then the only way to have a single rank over options is to also to have a preference over criteria: for example, if I’m choosing a car, and I have only two criteria, color and acceleration, then I also need to say which of the two influences desirability of options more – let’s say that acceleration is more important, which would lead me to choose, for example, a white car only if it had the best acceleration over all others I considered in the example where I prefer red to black to white cars.

Example: Decision making with the classical utility maximization model

Consider the following example.

In The Iliad by Homer, Achilles, the Greek hero, decides to withdraw from battle after a dispute with Agamemnon, the leader of the Greek forces during the Trojan War. Agamemnon, having been forced to return his war prize, Chryseis, to appease the gods, demands Achilles’ prize, Briseis, as compensation. In response, Achilles, feeling dishonored and enraged by Agamemnon’s actions, chooses to withdraw himself and his troops from the fighting, despite the consequences for the Greek army.

If we were to explain the decision using the simplified classical utility maximization model, then that explanation could look as follows.

Identifying Criteria: Achilles would begin by determining the criteria he will use to evaluate his options. These criteria reflect his preferences and could include:
- Preservation of personal honor.
- Contribution to the success of the Greek army.
- Personal safety and survival.
- The potential impact on his long-term reputation.
Identifying Options: Achilles would then identify the possible actions he could take. In his case, the primary options are as follows. Each option would be described in terms of its likely outcomes, such as the effect on Achilles’ honor, the Greek army’s success, and the risks to his life.
- Withdraw from battle, which would preserve his honor but potentially harm the Greek war effort.
- Continue fighting despite Agamemnon’s insult, maintaining military support but compromising his personal pride.
- Negotiate with Agamemnon to seek a compromise that might preserve both honor and military effectiveness.
Ranking Options on Each Criterion: Achilles would rank each option according to how well it satisfies each criterion. For example:
- Withdrawal may rank highest for preserving honor but lowest for contributing to military success.
- Continuing to fight might rank highest for military success but lower for personal honor.
- Negotiation could receive moderate rankings across multiple criteria.
Assigning Weights to Criteria: Achilles would assign weights to each criterion, reflecting how important each is to him. Hypothetical criteria are below. The weights over criteria would indicate the relative importance of each factor in influencing the decision.
- Honor might be assigned the highest weight if it is his most valued objective.
- Military success could be next, followed by personal safety and long-term reputation.
Selecting the Best Option: Using the rankings and weights, Achilles would calculate the overall score for each option. This score is a weighted average, combining how well each option meets the criteria with the relative importance of each criterion. He would then choose the option with the highest overall score. If preserving honor is weighted most heavily, and withdrawal ranks highest for honor, Achilles might decide to withdraw. Alternatively, if military success carries significant weight, continuing to fight might emerge as the best choice.

Table 1: Summary of hypothetical options Achilles had, the criteria they are compared against, and the values and rationale for scores of each option on each criterion. If criteria are equally important, the best option would be to withdraw from battle.
	Options
Criteria	Withdraw from Battle	Continue Fighting	Negotiate with Agamemnon
Preservation of Honor	5: Preserves honor by rejecting Agamemnon’s insult	2: Honor is compromised by accepting Agamemnon’s terms	4: Honor is partially preserved through compromise
Greek Army Success	1: Risks Greek army defeat without Achilles’ participation	5: Supports the Greek army, contributing to military success	3: Moderate benefit to the Greek army if an agreement is reached
Personal Safety	4: Ensures personal safety as Achilles is not in battle	3: Poses some personal risk but keeps Achilles in a strong position	3: Personal safety is balanced since Achilles avoids direct conflict
Long-term Reputation	3: Mixed impact on reputation; honor is upheld, but military retreat could be criticized	4: Positively impacts reputation as Achilles stays a key figure in the war	4: Could enhance reputation if a favorable compromise is reached

What is the explanation of a decision in this decision model?

In the classical utility maximization model, the explanation of a decision follows a simple pattern: the reason an option is chosen is because it is the one that was assessed as having the highest utility of all considered options.

This is a weak explanation, in that we are appealing to something that synthesizes a lot of other information. The explanation begs other questions. Why is the chosen option the most desirable? And then, What criteria did the decision maker use? What preferences do they have? What options did they consider?

It follows that factors which determine the decision according to the classical utility maximization model are the options, preferences, criteria, and the relative importance of criteria.

The figure below shows the structure of the probable explanation of a decision when we assume that the classical utility maximization model is a good representation of how the decision was made. For the background on this diagram, see the text here.

How to influence this decision process through governance?

As noted above, we need to consider guidelines and rules that influence:

Options, the variety and specificity
Criteria
Preferences
Criteria importance

Influencing Options

There are various ways to influence options that are considered during decision making. In general, we can do the following.

Decision Framing: The way a decision problem is framed impacts the range of options considered. For example, Tversky and Kahneman’s prospect theory shows that framing choices by emphasizing gains or losses can influence risk preferences. When decision-makers perceive the stakes as a loss, they are more likely to consider riskier options than when they see them as potential gains (Kahneman & Tversky, 1979).
Decision Situation: The culture and norms within the decision situation shape what is perceived as an option, and what is unlikely to be perceived as such. In a firm, a culture that encourages creativity, openness to diverse perspectives, and risk-taking typically results in a wider array of options being explored. Conversely, hierarchical or risk-averse cultures may limit the consideration of innovative or unconventional alternatives (Schein, 2010).
Structured Decision-Making Processes: Use of methods like decision analysis, scenario planning, or multi-criteria decision analysis can influence the range of options. Methods can make it mandatory to consider specific kinds of options, or to vary particular parameters to generate new options (Goodwin & Wright, 2014).
Mitigating Cognitive Biases: Decision-makers are often subject to cognitive biases like anchoring, availability bias, and confirmation bias, which can restrict the set of options they consider. Addressing these biases through techniques like “devil’s advocacy” or structured debate helps in challenging initial assumptions and broadening the range of potential alternatives (Bazerman & Moore, 2013). Encouraging teams to explore counterarguments or consider alternatives they initially dismissed can reduce the impact of biases.
Diverse Decision-Making Teams: Research highlights the importance of team diversity in expanding the range of options considered. Teams composed of individuals with varied backgrounds, expertise, and cognitive styles tend to generate more innovative ideas and are less likely to overlook unconventional solutions (Page, 2007). Diversity fosters critical thinking and prevents groupthink, where a homogenous group might converge too quickly on a narrow set of options.

Influencing Criteria and Preferences

Preferences and criteria go hand in hand: if there is no criterion to reflect a decision maker’s preference, then those preferences do not matter, and vice versa, if the decision maker wants to satisfy specific preferences they have, they will insist on introducing criteria which allow them to do so.

Influencing preferences requires understanding how they are formed, and consequently, what shapes them. Factors that influence criteria and preferences are the following.

Psychological Factors: Preferences are often influenced by cognitive biases, heuristics, and emotional states. Behavioral economics research has demonstrated that individuals’ preferences can deviate from rational expectations due to factors like loss aversion, overconfidence, or framing effects. For example, Kahneman and Tversky’s prospect theory shows that individuals are more sensitive to potential losses than to equivalent gains, shaping their risk preferences (Kahneman & Tversky, 1979).
Social Norms and Cultural Context: Social preferences, such as concerns for fairness, reciprocity, and status, can lead decision makers to value outcomes that align with societal expectations. Fehr and Schmidt (1999) found that individuals often make decisions based not just on self-interest but on considerations of fairness, driven by social norms. Cultural influences also shape values and behaviors, such as preferences for cooperation versus competition, which differ across societies (Akerlof & Kranton, 2000).
Institutional and Market Structures: Institutions, including market systems, laws, and organizational frameworks, also influence decision makers’ preferences. Exposure to different market structures can shape individuals’ preferences for certain behaviors, such as competition or collaboration. For instance, capitalist economies may foster preferences for individual achievement, while cooperative market structures might encourage collective decision-making (Bowles, 1998).
Learning and Experience: Preferences evolve based on individual experiences, information, and knowledge. Experienced and observed outcomes of past decisions shape future preferences. For example, a person who experiences financial losses in risky investments may develop a preference for safer investments in the future (Bisin & Verdier, 2011).
Time Preferences and Discounting: Individuals differently value present versus future outcomes. Time preferences, captured in models of discounting, reflect whether decision makers prefer immediate rewards or are willing to wait for future gains. For example, in some decision situations, decision makers may heavily discount future rewards, preferring immediate outcomes (Laibson, 1997).
Genetic and Biological Factors: Studies in neuroeconomics indicate that certain preferences, such as risk tolerance and time preferences, may have a biological basis influenced by brain activity (Camerer, Loewenstein, & Prelec, 2005). These factors contribute to the complexity of how preferences are formed.

To influence preferences through decision governance, we need to introduce mechanisms which shape preference factors. We will revisit in more detail how these factors can be influenced through decision governance in other texts.

References and Further Reading

Bazerman, M. H., & Moore, D. A. (2013). Judgment in Managerial Decision Making. Wiley.
Goodwin, P., & Wright, G. (2014). Decision Analysis for Management Judgment. Wiley.
Page, S. E. (2007). The Difference: How the Power of Diversity Creates Better Groups, Firms, Schools, and Societies. Princeton University Press.
Schein, E. H. (2010). Organizational Culture and Leadership. Wiley.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263–291.
Fehr, E., & Schmidt, K. M. (1999). A theory of fairness, competition, and cooperation. The Quarterly Journal of Economics, 114(3), 817–868.
Bowles, S. (1998). Endogenous preferences: The cultural consequences of markets and other economic institutions. Journal of Economic Literature, 36(1), 75–111.
Laibson, D. (1997). Golden eggs and hyperbolic discounting. The Quarterly Journal of Economics, 112(2), 443–477.
Bisin, A., & Verdier, T. (2011). The economics of cultural transmission and socialization. Handbook of Social Economics, 1A, 339-416.
Akerlof, G. A., & Kranton, R. E. (2000). Economics and identity. The Quarterly Journal of Economics, 115(3), 715–753.
Camerer, C. F., Loewenstein, G., & Prelec, D. (2005). Neuroeconomics: How neuroscience can inform economics. Journal of Economic Literature, 43(1), 9-64.