Behavioural W4 Flashcards
What does the completeness axiom say? Express it formally.
An individual must be able to compare and make a decision between 2 bundles of goods.
q>r, r>q or both.
What does the transitivity axiom say? Express it formally.
If an individual consistently ranks options in a certain order, then their preferences must be internally consistent and transitive.
If q>r and r>s then q must be > s.
What does the continuity axiom say? Express it formally.
If an individual strictly prefers one option to another, they can find an intermediate option that they are indifferent between.
If q>r and r>s, then (p : q ; 1-p : s) - r.
What does the independence axiom say.
The relative ranking of two options should not change when an irrelevant third option is introduced.
Why are the EUT axioms important.
- Consistency - individuals’ decisions are internally coherent and reflect stable preferences over uncertain outcomes.
- Predictive Power - researchers can make precise predictions about how individuals will behave under different scenarios.
- Comparative Analysis - researchers can compare preferences and behaviors in different contexts and identify similarities and differences in decision-making strategies.
What is the Allais Paradox.
Despite the options having equivalent expected values or probabilities, individuals exhibit inconsistent preferences, leading to contradictory choices.
Explain the Ellsberg Paradox.
Despite the lack of information about the probabilities, individuals must make decisions based on their preferences and attitudes towards risk.
Why do people chance their choice depending on how the question is framed in the ‘unusual disease’ problem by Tversky & Kahneman (1981).
People often change their choice depending on how the question is framed due to cognitive biases and heuristics that influence decision-making. Individuals are more sensitive to losses than gains.
What is the reflection effect.
Refers to the tendency for individuals to be risk-averse when faced with gains and risk-seeking when faced with losses.
What is Prospect Theory
Proposes that individuals evaluate outcomes relative to a reference point, rather than in absolute terms.
1. Value function.
2. Probability Weighting Function.
3. Decision Rule.
What is the endowment effect.
Individuals ascribe higher value to items they own or possess.
Explain the following three key features of Prospect Theory: reference dependence, loss aversion and diminishing sensitivity.
- Reference Dependence - individual’s choices influenced by framing.
- Loss Aversion - risk-averse behaviour in the domain of gains.
- Diminishing Sensitivity - more risk-averse for larger probabilities.
What is Original Prospect Theory.
- Weighting of probabilities.
- Evaluation of outcomes.
- Integration of probabilities and outcomes.
How do original and cumulative prospect theory differ.
CPT offers a more flexible and nuanced framework for understanding decision-making under uncertainty by incorporating context-dependent probability weighting functions and separate value functions for gains and losses.
Write about one of the criticisms of PT.
Limited ability to account for individual differences and context-dependent factors in decision-making.
PT’s focus on laboratory experiments and hypothetical decision scenarios may not fully capture the complexities of real-world decision-making contexts.
