Decision-Making Flashcards
What is Sunk-cost Fallacy?
Sunk-Costs- Costs beyond recovery when decision is made
- Should not affect decision - only Incremental costs
What is Opp. Cost?
Value of most valuable alternative option
- Max Utility of Other alternatives
c(ai) = max {u(a1), u(a2), … , u(ai-1), u(ai+1), … , u(an)}
What is Menu Dependence?
Preferences are influenced by Menu
- If x is chosen from {x, y} –> Assuming Indifference between x and y
– Must not choose y from menu {x, y, z}
BUT many people’s pref. change when menu expands
What is the Decoy Effect?
Decoy- Alternative dominated by another option + hence is NOT chosen
- Choice changes when Decoy is removed from Choice set - Intro of subpar option changes pref.
How can a Decoy have the desired impact?
Decoy must be Dominated by the Target by NOT by the Competitor
What is the Compromise Effect?
Tendency to choose Compromised Option or Middle option
- Sometimes due to Extremeness Aversion
When do we Observe the Endowment Effect?
When Buying Prices are Significantly Lower than Selling Prices
Willingness to Pay < Willingness to Accept
- E.E produced by giving Property Rights over Consumption Goods
What is Loss Aversion?
People dislike Losses more than they like gains of similar size
What is a Value Function?
A Func. that Represents how an agent evaluates a change in Endowment
What is the shape of the Value func. under Loss Aversion?
Kinked at Reference Point
- Steeper for values LESS than Reference Point
– Loss leads to Larger decrease in Value compared to gain in value for an increase of the same size.
|v(-x)| > v(x) for x > 0, x = Change in Endowment wrt. Ref. Point
What is the General Form of the Value Function?
v(c | r) = {u(gain) (c - r), if c - r ≥ 0; u(loss) (c - r), if c - r < 0}
c = Consumption, r = Reference Point
Can simplify w/ x = (c - r)
What is Diminishing Sensitivity?
People’s Sensitivity to Changes in an Outcome - Smaller for Outcome Levels further away from Ref. Point
When does. Value Func. exhibit Diminishing Sensitivity?
If v(.) is CONCAVE in Gains + CONVEX in Losses
What is Integrating an Outcome?
Bundling Gains/Losses together of multiple Outcomes
What is Segregating an Outcome?
Separating Gains/Losses of multiple Outcomes
- Adjust Ref. Point before assessing Value of Secon Outcome
