Chapter 9: Decision Making

Question 1

rational decisions (normative model)

Answer 1

• sets a standard & is based on economic theory
• ppl weigh alternatives, calculate the expected value of all possible outcomes & make appropriate decision
• ppl choose most valuable option in the long run

Question 2

expected value

Answer 2

• only works with you know outcomes & probability of outcome

EXAMPLE
1. Winning $40 w probability .20/ else nothing
- EV = ($40 x 0.20) - ($0 x 0.80) = $8.00

2. Winning $35 w probability 0.25/ else nothing
   - EV = ($35 x 0.25) - ($0 x 0.75) = $8.75

RESULTS
- 2nd choice is better b/c you have higher chance of winning

Question 3

framing effects

Answer 3

• change the way we make behaviours b/c it changes how we interpret task/decision
• frame decisions in way that avoids loss

Question 4

framing effects example

Answer 4

• disease in city will kill 600 ppl & 2 different programs are proposed
• 1A & 2C are both 600 ppl BUT A is framed that 400 will die and C is framed that 200 ppl will be saved

RESULTS
- A: 400 ppl die, but when framed as ‘saving’, ppl stick w certainty & risk avoidance
- C: 200 ppl will be saved but when framed as ‘dying’, ppl avoid loss & choose riskier alternative

Question 5

endowment effect

Answer 5

• give something more value b/c we own it

Question 6

status quo bias

Answer 6

• wants things to remain the same
• don’t want to lose what we already have

Question 7

sunk cost

Answer 7

• ppl are unwilling to abandon an undesirable status quo if they have already invested time or money

Question 8

satisficing

Answer 8

• setting a criterion or aspiration level then searching for the first alternative that is satisfactory according to that criterion

Question 9

prospect theory ** know the function graph

Answer 9

• ppl make decisions according to psychological prospects
• assumes objective probability can be replaced by psychological probability or beliefs
• loss aversion & risk aversion are primary motivators

Question 10

loss aversion

Answer 10

• occurs b/c psychological value assigned to giving up something or losing something is greater than the corresponding psychological value associated w obtaining same object
• prefer current circumstances

Question 11

risk aversion

Answer 11

• tendency of ppl to make decisions that avoid risk
• predicted by prospect theory & related to certainty effects

Question 12

certainty effect

Answer 12

• tendency for ppl to choose options w certain likelihood of occurrence