Decision Making II: Decision Heuristics & Mechanisms Flashcards
Decision Heuristics?
Applying simple rules to simplify decisions
Especially useful under uncertainty or incomplete information
Satisficing? (Herbert Simon, 1956)
“Satisfy” + “suffice”
When there are too many options, choose first one you see that is satisfactory
Predicting Business Success?
Canadian Invention Assessment Program
– High accuracy assessing viability of new products
– 37 attributes
Production cost, need for product, compatibility with current attitudes, advantages visible to consumer, promotion cost, distribtion cost, etc.
Number of “good” and “bad” attributes predicts future success >80% of the time!
Decision heuristics not always beneficial?
- Heuristic decisions can be subjective
- Can ve biased (limited information), like the Sunk cost fallacy bias
Expected Utility Theory?
Utility: something we can define, overall value for the decision maker, e.g. happiness, money, health, good grades
Utility Theory: People make decisions that maximize utility, given available information
- “rational” decision making
- Many deviations from expected utility!
Denes-Raj & Epstein (1994)?
Given the option to chose a red jelly bean from two different bowls
a) 1 out of 10 = 10%
b) 7 out of 100 = 7%
A non trival amout of people chose b).
Deveiation from executed utility theory
Expected Utility Theory pros & cons?
Pros:
– Provides “objective” benchmark to study decision making
– Easy to model
Cons:
– Biased prediction of real-world behaviour
– Don’t know how individuals define utility
Gains vs. Losses Example
Fair coin toss:
Heads = win $110
Tails = lose $100
Is it a good idea to take this bet?
Utility theory says yes
Although humans usually don’t, we hate losing existing recourses
Prospect Theory (Kahneman & Tversky)
- People tend to think in terms of gain and loss
– Relative to “reference point” - Gains and losses are represented differently in the mind
It is logirytmic meaning
Asymetry between gains and losses, losses are percived worse than gains are good
Risk Aversion?
When framed as gains, people avoid uncertainty
Risk Aversion?
Losses are more bad than gains are good
Risk of loss is worse than equal chance of gain
Is risk aversion rational?
Kahneman & Tversky (1979)
Also found risk aversion is dependent on framing, Gain vs. loss frame?
Gain options:
A. Get $3000
B. 80% chance to get $4000, 20% chance to get $0
Loss options:
A. Lose $3000
B. 80% chance to lose $4000, 20% chance to lose $0
When framed as gains, people avoid uncertainty
– Risk aversion
When framed as losses, people seek uncertainty
– Risk seeking
Gain frames shift reference point downwards
– Equivalent to adding a positive constant to all outcomes
Kahneman & Tversky (1981) - An unusual disease is expected to kill 600 people
Vaccine A
- 200 people will be saved
Vaccine B
- 1/3 probability that 600 people will be saved
- 2/3 probability that no people will be saved
Vaccine A
- 400 people will die
Vaccine B
- 1/3 probability that no one will die
- 2/3 probability that 600 people will die
First scenario: Moat people will pick Vaccine A! Will “save people”
Second scenario: Most people will pick Vaccine B! Reference point change, will “kill people”
If the reference point is high everything looks like losses and when the reference point is low everything looks like gains
Endowment Effect?
The prospect of a gain is smaller than the prospect of a loss
Therefore, when something is gained, its value increases
Endowment effect: over-valuation of current possessions given by ownership
Emotion and Decision Making?
One explanation for loss aversion is the asymmetry in emotional prediction
People are generally not good at predicting future emotions
