This can be illustrated from the opening example where the expected values
for Option 1 and Option 2 are respectively ($250,000 x 75%) and ($400,000 x
40%). Choosing between these options can be made by determining the
expected values of Options 1 and 2 which are set out in the following table:
Option
Profit
Probability
Expected Value
Option 1
250,000
75%
187,500
Option2
400,000
40%
160,000
Figure 9.7 Expected Values
At the table reveals, the expected value of Option 1 is $187,500 and of Option
2 $160,000. This indicates that Option 1 is a better investment than Option 2.
This example shows how expected value produces a measure of the return for
each outcome which enables us to compare the returns. In turn this enables us
to make a decision because we take the outcome with the best return.
Thus, expected
value is a method, involving a calculation, which is used to
take into account uncertainty. By their nature, decisions take their effect in the
future and the future is inherently uncertain.
This is why expected value is used in business to make investment decisions
that are needed when a new project, be it large or small, is contemplated. In
law expected value, or at least the reasoning process that underlies it, can be
used for making and interpreting law. Those making and interpreting law can
use expected value to factor in the possibility that the predicted costs and
benefits of a law or an interpretation of a law may not come about. Expected
value can also be deployed in making the decision whether to litigate. Further,
on one analysis the tort of negligence incorporates expected value.
244
Calculation
To find the expected value and use it for decision making we need to take
several steps. In the real world these would also include making adjustments
for the time value of money when moving from one time period to another.
This however, is omitted here. These steps are as follows:
#
Step 1: Choices. Work out the choices that the person faces.
#
Step 2: Identification of Gains and Losses. Calculate the gains
and losses from each choice.
___________________
244
United States v Carroll Towing 159 F 2d 169, 173 (2nd Cir, 1947) per Learned
Hand J, United States Fidelity and Guarantee Co v Jadranska Alobodna
683 F 2d 1022
(7th Cir, 1982), McCarry v Pheasant Run 826 F 2d 1554 (7th Cir, 1987)
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