4 decision making

Question 1

theories of value based decisions

Answer 1

• expected value, but people are risk averse >
• expected utility, but framing effects >
• prospect theory

Question 2

how does expected utility explain risk aversion

Answer 2

• utility function is concave
• so subjective value of £200 is not 2x £100

Question 3

what is prospect theory

Answer 3

• outcomes aren’t valued as end states but changes from a reference point
• value function is convex for losses - you are less sensitive to bigger losses
• gradient for curve is 2x steeper in loss domain > losses loom larger than gaines

Question 4

what is the endowment effect - support or oppose prospect theory?

Answer 4

people value an item they alr own more than they would be prepared to pay for the same item if they did not own it - supports prospect theory

Question 5

is there a linear relationship between stated probability and its effective value in the decision process - support or oppose prospect theory?

Answer 5

• no
• rare events and guaranteed outcomes are overweighted
• support

Question 6

example of decoy effects - support or oppose prospect theory?

Answer 6

• you add a third example and people’s preferences shift > e.g. more chose apple than orange but with banana more choose orange than before
• opposes