Certainty Equivalent


Health Economics

  • The certain and sure money or utility ('sure thing') that a subject would have to receive to be indifferent between it and a given gamble ('uncertain prospect') is called the gamble's 'certainty equivalent'. The certainty equivalent is less than the expected value of the gamble if an individual has a diminishing marginal utility of money income and obeys the axioms of expected utility theory. This indicates a kind of risk aversion. In health economics, the usual experiment contains a certain outcome, such as five years of healthy life, and an uncertain prospect consisting of the combination of two or more uncertain outcomes such as probability p of having two years of healthy life and probability (1 - p) of having 15 years of healthy life. P is then experimentally adjusted until there is indifference between the certain and the uncertain prospects. One purpose of such experiments is to determine the value attached to an outcome, given values attached to the others.