Bounded Rationality I Flashcards
what are descriptive models of theory?
Models of how decision processes operate, irrespetice of whether the outcome of the decision is good or bad
what are Normative models of theory?
evaluate a decision in terms of the goals of the decision maker. Here, decisions can be good or bad and a decision is good if it reaches these goals
what is a rational decision?
it maximizes the expected value
what are the assumptions of rational decisions?
- Assumes the agent has full access to all alternatives
- Knows the probability of their outcomes
- Knows the value of their outcomes
what are the factors of rational choice theory/rational behaviour?
- Assumes the agent has full access to all alternatives
- Knows the probability of their outcomes
- Knows the value of their outcomes
- Can integrate all this information and chooses the option / behaviour with highest utility
What is bounded rationality by Herbert A Simon?
- Limited cognitive capacity, limited information on outcomes
Human behaviour can be - impulsive
- habitual / conditioned
- imitating others
- random
what is choice under uncertainity?
- Given a choice between two or more alternatives the rational choice is the option with the highest value or utility.
- If the outcomes are uncertain we multiply the utility by the probability of receiving that outcome to give the expected value EV.
EV = p(outcome) * value
what is The St Petersberg Pradox?
a case where Rational choice theory fails to make sensible predictions about “rational choice
how does the St Petersburg Petersburg Paradoxon shows an inherent limitation of expected value?
Despite its seemingly plausible or trivial nature, it is not general enough for many situations – even under the assumption that the decision maker behaved entirely rational (in terms of maximising their gains)
what is Expected Utility Theory?
- a normative theory, it clearly defines what rational choices are. Expected utility may, however, deviate from expected value in that
- it allows the expected utility of a particular choice outcome to be situationally dependent, e.g. dependent on the accumulated wealth
- uses weak ordeing (For any set of choices we must always be able to say we prefer one over the other or neither)
- uses Transivity (choices must be transitive)
Risk seeking vs risk averse behaviour
when people have the chance of making gains they prefer the certain option
When people have a chance of loss they choose the more uncertain loss
Prospect Theory (Kahneman and Tversky)
- a descriptive model of decision making
- Intended to account for deviation from rational choice theory
- Prospect theory has 2 main components: Utility and Probability
what is the value function? Tversky and Khaneman (1981)
- model that differs for gains and losses
-The x-axis reflects gains to the right and losses to the left instead of total wealth as Bernoulli described. The midpoint is a person’s current reference point. - The y-axis is utility.
- Function for gains and losses are asymmetric. This explains why we treat losses as more serious than gains.
what is The π function?
- For gains, people prefer certainty
- we do not treat probabilities as they are stated. For instance, in a lottery, the EV is very low: the probability of winning is negligible
- they are distorted by the pi function
- Probabilities near 0 are overweighted relative to objective probabilities, probabilities near to 1 (but not 1) are underweighted
what is regret theory?
- we compare outcomes, particularly after the decision has been made.
- The assumption is, we will regret a decision if an alternative outcome would have led to a higher payoff (even when the prospect was better).
- we rejoice if our choice led to a better outcome than other alternatives.
