Behavioural Economics

Question 1

Prospect theory

Answer 1

Prospect theory highlights an inconsistency with expected utility theory as humans have different risk attitudes for positive and negative prospects

Question 2

Main difference between the utility function and the value function ?

Answer 2

Normal expected utility theory implies decisions should be made with respect to final wealth, whereas prospect theory suggests value is defined over gains and losses

Question 3

Describe the prospect theory value function (can’t do images on brainscape)

Answer 3

• The value function is twice as steep for losses as for gains
• For losses people become risk seeking but for gains people are risk averse

Question 4

What is the prospect theory probability weighting function ?

Answer 4

Plots probability against decision weight, and shows for probabilities near 0 and near 1 humans struggle to view as linear

Question 5

Core Heuristics (rules of thumb)

Answer 5

1. Availability
2. Representativeness
3. Anchoring
4. Overconfidence

Question 6

Availability (core heuristic)

Answer 6

If something is more available we see it as more likely, such as recent terror attacks making people think they’re more likely to happen again

Question 7

Repressentativeness

Answer 7

Adding extra details makes an outcome less likely, however if it makes sense within the context than people we see that outcome as more probable. For example, a random women being a pregnant english teacher seems more likely then them just being an english teacher but this is wrong

Question 8

Anchoring

Answer 8

Context can shape decisions to push you towards them