bias and decision making 1 - rationality and uncertainty

Question 1

define rationality

Answer 1

when decision making appears to be rational

it is a set of norms

Question 2

norms with reasoning

Answer 2

rules of action or thought which define optimality

Question 3

rationality as a set of norms - 2 features (which can be errors)

Answer 3

coherence –> needs to be consistent across decisions

correspondence –> needs to correspond to reality, not a mismatch

Question 4

availability bias (+what error is this)

Answer 4

over-estimating the frequency of rare or memorable events

e.g. plane crashes

this is a correspondence error - mismatch between reality (environment) and response (belief about event frequency)

Question 5

framing bias (+what error is this)

Answer 5

switching decision based on question framing

e.g. would you buy another ticket if you dropped it on the way to the cinema vs if you dropped £10 on the way to the cinema

coherence error - making a different decision based on the same outcomes - not consistency across decisions

Question 6

the Linda problem

Answer 6

description of a woman and then were asked whether it is more likely she:
- works at a bank OR
- works at a bank and is an active feminist

rational response:
- option 1 must be more likely than option 2 as 2 is a subset of 1
- option 2 requires two things to be true whereas option 1 only needs one

Question 7

what the Linda problem shows

Answer 7

most people say option 2 (she works at a bank and is a feminist)

this is in defiance of norms of laws of probability

this is making a conjunction fallacy –> an error in reasoning by assuming that the specific condition is more probable than one more general condition

Question 8

conjunction fallacy

Answer 8

error in reasoning

assume that specific condition are more probable than a general condition

shown by the Linda problem

Question 9

decision calculus (3 components)

Answer 9

make rational decisions using:

• logics
• probabilities
• systematic consideration of all options

Question 10

4 difficulties in making decisions

Answer 10

1. the future is uncertain
2. need to assess risks and benefits
3. need to choose to increase chance of positive outcome
4. need to use knowledge to estimate probabilities of future events

Question 11

rationality - probability based on value

Answer 11

expected value = value an investment will have in the future

good bet = expected value is greater than investment
bad bet = expected value is less than investment

rational choice = invest to maximise the expected value

Question 12

risk aversion

Answer 12

tendency to accept a sure outcome over a riskier one - even if the outcome results in less gain

Question 13

two components considered with decision calculus

Answer 13

value and utility

Question 14

expected utility theory - general idea

Answer 14

decision making method –> calculate the option with the highest expected utility

rational = choose option which maximises our utility

premise:

• theory of decision under risk
• each option leads to one set of outcomes
• probability is known

Question 15

value vs utility on line graphs against quantity

Answer 15

value = linear increase with quantity

utility = fast increase then curves and more plateaus with greater quantity

with utility - it gets to a point where you’ve had enough and so you don’t value it as highly as you did at the start

Question 16

marginal utility

Answer 16

utility relative to how much of an item you have - if you have more you value additions to it less

Question 17

marginal utility + wealth

Answer 17

diminishing marginal utility of wealth:

as amount of money you have increases, each addition to it becomes less important

this is a subjective personal point of view

e.g. giving a billionaire vs a uni student an extra £1000 means different things to them

Question 18

value vs utility

Answer 18

utility is compressed with respect to value

e.g. you don’t enjoy 10 pizzas 10x as much as 1 pizza, but it does still cost 10x more than 1

value and cost are much more in line whilst utility is more about enjoyment/preference and how it contributes to wellbeing or satisfies desires

Question 19

value vs utility with coin flip example

Answer 19

option a - coin flips- head win £1000, tails win 0,
option b - no coin flip = £499

expected value:
b = £499
a = £500
–>but most still opt for b

utility attached to first £499 is greater than the additional £501

can measure utility using “willingness to pay”

according to Expected Utility Theory –> people should behave to maximise Expected Utility

Question 20

uncertainty affects expectation - pizza example

Answer 20

if you would pay £10 for 1 pizza

then how much would you pay for a 10% chance to win a pizza

or a pizza which had a 1/100 chance of making you sick

these add risk into the equation

Question 21

equation for expected utility

Answer 21

E = p*U

E = expected utility
p = probability
U = utility

e.g. expected utlity of a bet with a 50% chacne of a £40 pay off –> E = 0.5*40 –> E = 20 –> should take the bet if E is higher than investment according to expected utility theory

Question 22

equation for expected utility with multiple options

Answer 22

E = p1U1 + p2U2 etc…

E = expected utility
p = probability
U = utility

e.g.
a £15 bet with a 20% chance of paying £50 and a 10% chance of paying £100
investment = £15
E = 20
therefore should take the bet as E > investment

Question 23

the effect of uncertainty

Answer 23

need to understand probability distributions

e.g. if somethings is probable good, there could still be a small chance it goes bad

can picture this as curves on a graph with high and low utility on the x axis

Question 24

loss aversion and prospect theory

Answer 24

bias in decision making

if there is guaranteed loss –> people opt for option where loss may or may not happen rather than optimal utility

aversion to guaranteed loss

e.g. having £100 and loosing £50 feels worse than having £0 and gaining £50 even though result is the same

e.g. would you accept coin toss when heads = +£1500 and tails = -£1000

innate motive to prefer avoiding losses rather than achieving similar gains

feel the pain of loss more than the pleasure of an equivalent gain