The Gorman Lectures in Economics

"series
Rational Decisions
Editor, Richard Blundell

Lawlessness and Economics: Alternative Modes of Governance,

,Avlnash K. Dbdt

Rattonal Dectstons,
Ken Blnmore
Ken Binmore

A sertes statement appears at the back of the book

Princeton UniversitY Press

Princeton and Oxford
pü ?il$" "sds f #tr?
tr 3

ssd

Copyright O 2009 by princeton University press

Published by Princeton University press,
41 William Street, Princeton, New Jersey 08S40
In the united Kingdom: Princeton unir¡ersity press,
6 Oxford Street, Woodstock, Oxfordshire OX20 lTW
All Rights Reserved This book began with two lectures I gave in 2006 at
ISBN: 978-0-691-1 3074-3 (alk. paper) University College London in memory of
Library of congress control Number: 200gg3BSt3 Terence Gorman
British Library caraloging-in-publication Data is available who was a great economist and" a good friend. He would
have wished me to dedicate this book to the fondly
This book has been composed in LucidaBright
Typeset by T&T Productions Ltd, London
remembered teacher at his grammar school in Northern
Printed on acid-free paper
Ireland who first inspired him with a love of mathematics.
@

press.princeton.edu

Printed in the United States of America

10 9 B 7 6543
 Contents

1X
Preface

1 Revealed Preference 1

1.I RationalitY? 1

L.2 Modeling a Decision Problem 2

1.3 Reason Is the slave of the Passions 3

T.4 Lessons from AesoP 5

1.5 Revealed Preference 7

1,6 RationalitY and Evolution T2

L7 Utility I4
1.8 Chatlenging Transitivity L7
1.9 Causal lJtilitY FallacY 19
1.10 Positive and Normative 22

2 Game TheorY 25
2.I Introduction 25
2,2 What Is a Game? 25
2.3 Paradox of RationalitY? 26
2.4 Newcomb's Problem 30
2.5 Extensive Form of a Game 31

3 Risk 35
3.1 Risk and UncertaintY 35
3,2 Von Neumann.and Morgenstern 36
3.3 The St Petersburg Paradox 37
3.4 ExPected lJtilitY Theory 39
3.5 Paradoxes from A Ío Z 43
3.6 UtilitY Scales 46
3.7 Attitudes to Risk 50
3.8 lJnbounded UtilitY? 55
3.9 Positive APPlications? 5B

4 Utititarianism 60
4.I Revealed Preference in Social Choice 60
4.2 Traditional Approaches to lltilitarianism 63
4.3 IntensitY of Preference 66
4.4 Interpersonal Comparison of utility 67
 vilt ('(tnl t, ttl,t

5 Classical Probability 75
5.1 Origins 75
5.2 Measurable Sets 75 Preface
5.3 Kolmogorov's Axioms 79
5.4 Probability on the Natural Numbers B2
5.5 Conditional Probability B3
5.6 Upper and Lower Probabilities BB

6 Frequency 94 Whatisrationality?Whatisthesolutiontotheproblemofscien-to
answers
6.1 InterpretingClassicalProbability 94 tific induction? I don't think it reasonable to expect thgn
6.2 Randomizing Devices 96 suchquestions'onemightaswellaskforprecisedefinitionsoflife.
6.3 frontier of
the
6,4
Richard von Mises 100 or consciousness. But wé can still try to push forward
Refining von Mises' Theory r04
6.5 Totally Muddling Boxes 113
rationa]decisiontheorybeyondtheBayesianparadigmthatrepresents
the current orthodoxy'
7 Bayesian Decision Theory r16 Manypeopleseenoneedforsuchaneffort'TheythinkthatBayesian-
7.I Subjective Probability 116 ismatrea¿yprovidestheanswerstoallquestionsthatmightbeasked.I
7.2 Savage's Theory that their theory
believe that Bayesians of this stamp fail to understand
LT7
7.3 Dutch Books L23 a small world in his
7.4 Bayesian Updating L26 applies only in what Jimmie Savage (1951) called
scientific inquiry is
7.5 Constructing Priors L29 fárrror6 Foundations of statistics. But the world of
7.6 Bayesian Reasoning in Games 134 large_somuchsothatscientistsofthefuturewilllookbackwith
incredulity at a period in intellectual history when
it was possible be
I Epistemology L37
tl.1 Knowledge r37 takenseriouslywhenclaimingthatBayesianupdatingisthesolutionto
8.2 Bayesian Epistemology L37 the problem of scientific induction'
-Jact<coo¿onceclaimedtoidentify46,656differentkindsofBayesians'
¡1.3 Information Sets 139
8.4 Knowledge in a Large World r45 fUV tirr, piiority is therefore to clarify what I think should be regarded
f3.5 Revealed Knowledge? r49
astheolthodoxyonBayesiandecisiontheory_thesetoffoundational
I Large Worlds r54 assumptionsthatofferthefewesthostagestofortune'Thistakesup
9.1 Complete Ignorance L54 mostofthebook,sinceltaketimeouttoteviewvariousaspectsofprob.
9.2 Extending Bayesian Decision Theory so much time offer-
9.3 Muddled Strategies in Game Theory
163
ability theory along the way, My reason for spending
169 theory is that I feel the
9.4 Conclusion 174 irrg uá rrt,.u_orthodox review oi standard decision
(both positive and negative)
need to deny numerous misapprehensions
10 Mathematical Notes 175 about what the theory really ráyr-or what I think
it ought to say-before
10.1 Compatible Preferences decision
10.2 Hausdorff's Paradox of the Sphere
175
getting on to my own attempt to extend a version of Bayesian
177 (chapter 9)'
ifruory to worlds larger tharrthose considered by
Savage
10.3 Conditioning on Zero-Probability Events 177 of Bayesian decision
L0.4 Applying the Hahn-Banach Theorem 179 I don,t for one ,rroá.rra imagine that my extension
10.5 Muddling Boxes 180 theorycomesanywherenearsolvingtheproblemofscientificinduction'
10.6 Solving a Functional Equation useful in applica-
181 but I do think my approach will sometimes be found
L0.7 Additivity strategies of game theory
tions. For example, my ttleory allows the mixed
182
10.8 Muddled Equilibria in Game Theory I82 (much as pure strategies
to be extended to what I caII muddled strategies
References 189 wereextend.edtomixedstrategiesbythecreatorsofthetheory).
What is the audience for this book? I hope that
it will b¡ read not
Index
just by the economics community from which I come myself' but
197 also
"¡y
,tuii*ti.ians ancl philosophers. If it only succeeds in bridging
some
 x preface

of the gaps between these three communities, it will have been worth-
while. Howevern those seeking a suruey of all recent research will need to
look for a much bigger book than this. I have tried to include references
to literatures that lie outside its scope, but I never stray very far from
my own take on the issues. This streamlined approach means that the
book may appeal to students who want to learn a little decision theory
without being overwhelmed by masses of heavy mathematics or erudite
philosophical reasoning, as well as to researchers in the foundations of Rational Decisions
decision theory.
sections in which I haven't succeeded in keeping the mathematics at
a low level, or where the going gets tough for some other reason, are
$ indicated with an arrow pointing downward in the margin. when such
an arrow appears, you may wish to skip to the next full section.
Finally, I want to acknowledge the debt that everyone working on deci-
sion theory owes to Duncan Luce and Howard Raiffa, whose Games and
Decisions remains a source of inspiration more than fifty years after
it was written. I also want to acknowledge the personal debt I owe to
Francesco Giovaruroni, Larry samuelson, Jack Stecher, peter wakker, and
Zibo Xu for their many helpful comments on the first üaft of this book.