Decision Making (Risky choice) Flashcards
What is a decision?
A choice between alternatives that is intended to produce a desired or favourable outcome
A choice between alternatives that is intended to produce a desired or favourable outcome
This is known as…?
A decision
What are the 4 types of choices/decision-making?
- Riskless Multiattribute Choice
- Intertemporal choice
- Decisions under uncertainty
- Decisions under risk
What is Riskless Multiattribute Choice?
Making decisions by evaluating and prioritising a limited set of alternatives based on multiple conflict attributes with no risks
Making decisions by evaluating and prioritising a limited set of alternatives based on multiple conflict attributes with no risks
This is known as…?
Riskless Multiattribute Choice
You go to a supermarket, you found some beans with different types of attributes.
You have to decide which can of beans to buy based on those attributes.
You can easily take it off the shelf and it is yours. There are no probabilities involved.
What type of decision is this…?
Riskless Multiattribute Choice
What is intertemporal choice?
Choosing between options available at different points in time
Simply = Deciding between smaller, sooner and larger, later rewards
Choosing between options available at different points in time
Simply = Deciding between smaller, sooner and larger, later rewards
This is known as…?
Intertemporal choice
When one of the attributes varies is time
a. Intertemporal choice
b. Riskless Multiattribute Choice
c. Decisions under uncertainty
d. Decisions under risk
a. Intertemporal choice
When there are no probabilities involved
a. Intertemporal choice
b. Riskless Multiattribute Choice
c. Decisions under uncertainty
d. Decisions under risk
b. Riskless Multiattribute Choice
What is the typical decision people make when they have to make a intertemporal choice?
People prefer immediate rewards over later rewards even if later rewards are greater
Would you rather receive £10 right now, or £25 one year from today?
This is an example of…?
a. Intertemporal choice
b. Riskless Multiattribute Choice
c. Decisions under uncertainty
d. Decisions under risk
a. Intertemporal choice
Making a decision whilst not knowing what your probabilities are
a. Intertemporal choice
b. Riskless Multiattribute Choice
c. Decisions under uncertainty
d. Decisions under risk
c. Decisions under uncertainty
What are decisions under uncertainty?
Making a decision whilst not knowing what your probabilities are
When one or more of the possible outcomes are probabilistic (i.e., they are not certain to occur)
Simply = Making a decision whilst knowing what your probabilities are
a. Intertemporal choice
b. Riskless Multiattribute Choice
c. Decisions under uncertainty
d. Decisions under risk
d. Decisions under risk
What are decisions under risk?
When one or more of the possible outcomes are probabilistic (i.e., they are not certain to occur)
Simply = Making a decision whilst knowing what your probabilities are
Sometimes the probabilities are not known precisely, in which case the decision may be referred to as …?
Under uncertainity
Sometimes risky choices are made from…?
“From description” (information about the options is explicitly presented – e.g., in writing)
Sometimes risky choices are made “from description” (information about the options is explicitly presented – e.g., in writing)
Other choices are made from…?
“From experience” (the decision-maker has to
learn the outcomes and their probabilities by repeatedly sampling the environment)
Decisions made when:
The decision-maker has to
learn the outcomes and their probabilities by repeatedly sampling the environment
This is known as…?
Decisions made from experience
Decisions made when:
Information about the options is explicitly presented
This is known as…?
Decisions made from description
What are decisions made from description?
Decisions made when:
Information about the options is explicitly presented
What are decisions made from experience?
Decisions made when:
The decision-maker has to
learn the outcomes and their probabilities by repeatedly sampling the environment
Choices made from description and from experience are made when faced with _____ choices
Risky
How do we make risky choices?
List 2 ways
- Choices from description
- Choices from experience
A. An 80% chance of £4000 (and a 20% chance of nothing)
B. £3000 for sure
Would you rather play A or B?
What type of choice is this?
Risky choice
What is a rational choice?
Choices people make if they sought to maximise their well-being and to behave consistently
Choices people make if they sought to maximise their well-being and to behave consistently
This is known as…?
Rational decisions
Name one way we could potentially make a rational decision
We could calculate the expected value
What is the expected value (EV)
The sum of each possible outcome weighted by its probability
The sum of each possible outcome weighted by its probability
This is known as…?
Expected value (EV)
What is the formula for expected value (EV)?
EV = p1a1 + p2a2 + p3a3….pNaN
EV = p1a1 + p2a2 + p3a3….pNaN
What is ‘a’ in this formula?
The value of the outcome
EV = p1a1 + p2a2 + p3a3….pNaN
What is ‘p’ in this formula?
The probability of the outcome
EV = p1a1 + p2a2 + p3a3….pNaN
What is ‘N’ in this formula?
The total number of outcomes
One potentially-rational way to choose between gambles would be to …?
Calculate the expected value (EV) of each option by weighting each outcome by its probability
Calculate the expected value (EV) for each option when:
Option A: An 80% chance of £4000
Option B: £3000 for sure
Option A:
EV = (0.80 x £4000) + (0.20 x £0) = £3200
Option B:
EV = 1.0 x £3000 = £3000
Option A: An 80% chance of £4000
EV = (0.80 x £4000) + (0.20 x £0) = £3200
Option B: £3000 for sure
EV = 1.0 x £3000 = £3000
Which choice is the more rational one?
Option A: An 80% chance of £4000
EV = (0.80 x £4000) + (0.20 x £0) = £3200
Option A: An 80% chance of £4000
EV = (0.80 x £4000) + (0.20 x £0) = £3200
Option B: £3000 for sure
EV = 1.0 x £3000 = £3000
Option A is the more rational choice but what % of people choose Option B? What does this mean?
80%
It means people are ‘risk averse’ for gains (they chose lower risk of not receiving any money)
Define risk averse
People choose the option with the lower risk of not receiving any reward
People choose the option with the lower risk of not receiving any reward
This is known as…?
Risk averse
80% chose the guaranteed 3000 rather than the risky option with higher expected returns
What does this mean?
They were risk averse for gains
Economists long ago replaced expected value with …?
Expected utility
What is utility?
The subjective value of an outcome, and is some transformation u(a) of the objective amount.
The subjective value of an outcome, and is some transformation u(a) of the objective amount
This is known as…?
Expected utility
What is the formula for expected utility (EU)?
EU = p1u(a1) + p2u(a2) + p3u(a3) …pNu(aN)
EU = p1u(a1) + p2u(a2) + p3u(a3) …pNu(aN)
What does ‘u’ mean in this formula?
The identity function
How does expected utility (EU) theory readily accommodate risk aversion?
Proposes that the utility function is concave
People have diminishing sensitivity to increasingly large gains so that the subjective value of (for example) £200 is not twice that of £100
True or False?
People have increased sensitivity to increasingly large gains
False
People have decreased sensitivity to increasingly large gains
True or False?
Decisions made according to expected utility are irrational
False
Decisions made according to expected utility are rational
Decisions made according to expected utility are rational
Why?
They conform to and follow from a set of axioms whose reasonableness it is hard to dispute
(for example, that if A is preferred to B and B is preferred to C then A is preferred to C)
Calculate the expected utility (EU) for each option when:
Option A: An 80% chance of £4000
Option B: £3000 for sure
Option A:
EU = 0.8 x u(£4000) + 0.2 x u(£0)
= 0.8 x 145 = 116
Option B:
EU = 1.0 x u(£3000)
= 1.0 x 122 = 122
Option A: An 80% chance of £4000
EU = 0.8 x u(£4000) + 0.2 x u(£0)
= 0.8 x 145 = 116
Option B: £3000 for sure
EU = 1.0 x u(£3000)
= 1.0 x 122 = 122
What do the results show?
The preference for B simply requires that the utility of £3000 is more than 80% of the utility of £4000, which we can see is the case
What is an advantage of making decisions based on the expected utility theory?
It is a rational, prescriptive account of choice
What is a disadvantage of making decisions based on the expected utility theory?
It is a poor description of reality
Simply = It does not provide an accurate description of how people actually behave
A rational, prescriptive account of choice but a poor description of reality
This applies to…?
Expected utility theory
The disadvantage of the expected utility theory led to the development of a major alternative known as…?
The Prospect Theory
The Prospect Theory is a theory developed to address the limitation in the________ theory
Expected utility
It does not provide an accurate description of how people actually behave
a. Prospect theory
b. Expected value theory
c. Expected utility theory
d. Rational decision theory
c. Expected utility theory
In addition to whatever you own you have been given:
£1000
Now choose:
A: 50% chance of £1000
B: £500 for sure
What % of people chose Option A?
16%
In addition to whatever you own you have been given:
£1000
Now choose:
A: 50% chance of £1000
B: £500 for sure
What % of people chose Option B?
84%
In addition to whatever you own you have been given:
£2000
Now choose:
C: 50% chance of -£1000
D: -£500 for sure
What % of people chose Option C?
69%
In addition to whatever you own you have been given:
£2000
Now choose:
C: 50% chance of -£1000
D: -£500 for sure
What % of people chose Option D?
31%
What contributes to the violation of decisions made based off of expected utility?
Framing
i.e. framing the options as a gain results in choosing the option that is certain
i.e. framing the options as a loss results in choosing the option that involves a probability/gambling
Framing the options as a gain results in choosing the option that is
a. certain
b. a probability
a. certain
Framing the options as a loss results in choosing the option that involves …?
a. certain
b. a probability
b. a probability
Assumes that losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of perceived losses
Which theory assumes this?
Prospect theory
What does the prospect theory assume?
Assumes that losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of perceived losses
Who thought of the prospect theory?
Kahneman and Tversky
What theory did Kahneman and Tversky propose?
Prospect theory
What is the fundamental problem with the expected utility theory?
It concerns the subjective value of final outcomes. But real decisions often violate this principle.
E.g. One’s ultimate state of wealth after playing a gamble
It concerns the subjective value of final outcomes. But real decisions often violate this principle.
E.g. One’s ultimate state of wealth after playing a gamble
This is a problem for…?
a. Expected utility theory
b. Expected value theory
c. Prospect theory
a. Expected utility theory
What is the reference point?
When outcomes can be considered as gains or losses with respect to a reference point.
Often the status quo
Simply = Outcomes can be framed to appear favourable if they are presented as an opportunity to gain something relative to a reference point, whereas they can also be framed to appear unfavorable, if they are presented as a loss relative to a given reference point
According to the prospect theory, outcomes can be framed to appear favourable if they are presented as ….?
An opportunity to gain something relative to a reference point
According to the prospect theory, outcomes can be framed to appear unfavourable if they are presented as ….?
A loss relative to a given reference point
What did Kahneman and Tversky (1979) do in their study on the prospect theory?
List 3 points
- Presented two decision tasks:
Task 1: In addition to whatever you own, you have been given £1000. You are now asked to choose between:
A. A 50% chance to gain £1000
B. Gaining £500 for sure
Task 2: In addition to whatever you own, you have been given £2000. You are now asked to choose between:
C. A 50% chance to lose £1000
D. Losing £500 for sure
Kahneman and Tversky (1979):
- Presented two decision tasks:
- Task 1: In addition to whatever you own, you have been given £1000. You are now asked to choose between:
A. A 50% chance to gain £1000
B. Gaining £500 for sure
- Task 2: In addition to whatever you own, you have been given £2000. You are now asked to choose between:
C. A 50% chance to lose £1000
D. Losing £500 for sure
Which option did the majority choose? and what % of people chose the option in Task 1?
84% chose Option B or sure gain
(Risk averse for (perceived) gains)
Kahneman and Tversky (1979):
- Presented two decision tasks:
- Task 1: In addition to whatever you own, you have been given £1000. You are now asked to choose between:
A. A 50% chance to gain £1000
B. Gaining £500 for sure
- Task 2: In addition to whatever you own, you have been given £2000. You are now asked to choose between:
C. A 50% chance to lose £1000
D. Losing £500 for sure
Which option did the majority choose? and what % of people chose the option in Task 2?
69% chose Option C or riskier option
(Risk seeking for (perceived) losses)
The preference reversal between the two versions of the task violates …?
List 2 things
- Rationality
- The Expected Utility account of decision-making
People are risk _____ for (perceived) gains
a. Seeking
b. Averse
c. Neutral
b. Averse
People are risk ______ for (perceived) losses
a. Seeking
b. Averse
c. Neutral
a. Seeking
Risk averse for (perceived) _______
a. Neither gains nor losses
b. Losses
c. Both gains nor losses
d. Gains
d. Gains
Risk seeking for (perceived) losses
a. Neither gains nor losses
b. Losses
c. Both gains nor losses
d. Gains
b. Losses
According to the prospect theory, rather than basing decisions on the expected utility of end-states, people seem to focus on …?
Changes in wealth with respect to a reference point
According to the prospect theory, rather than basing decisions on the expected utility of end-states, people seem to focus on changes in wealth with respect to a reference point
What is the reference point?
This reference point is usually the status quo, but may also be an aspiration level or some other salient value
Kahneman and Tversky’s (1979) Prospect Theory posits an ______ value function
a. T-shaped
b. S-shaped
c. V-shaped
d. U-shaped
b. S-shaped
Kahneman and Tversky’s (1979) Prospect Theory posits an S-shaped value function which is _______ for gains
a. Concave
b. Convex
a. Concave
Kahneman and Tversky’s (1979) Prospect Theory posits an S-shaped value function which is ______ for losses
a. Concave
b. Convex
b. Convex
Kahneman and Tversky’s (1979) Prospect Theory posits an S-shaped value function which is concave for gains and convex for losses, where gains and losses are defined with respect to the …?
Current reference point
According to Kahneman and Tversky’s (1979) Prospect Theory, people show diminishing sensitivity to …?
List 2 things
- Progressively larger increases from the reference point
- Progressively larger decreases from the reference point
According to Kahneman and Tversky’s (1979) Prospect Theory, people show diminishing sensitivity to progressively _____ increases from the reference point, and diminishing sensitivity to progressively ______ decreases from the reference point
a. Smaller, Smaller
b. Smaller, Larger
c. Larger, Smaller
d. Larger, Larger
d. Larger, Larger
What does diminishing sensitivity mean when given options framed as gains?
The small but guaranteed gain has more than half the subjective value of a larger gain, so people take the safe option.
The small but guaranteed gain has more than half the subjective value of a larger gain, so people take the safe option.
Does this increase or decrease sensitivity?
Decrease
What does diminishing sensitivity mean when given options framed as losses?
The small but sure loss seems worse than the chance of losing something much larger, so people are prepared to take the risk
The small but sure loss seems worse than the chance of losing something much larger, so people are prepared to take the risk
Does this increase or decrease sensitivity?
Decrease
True or False?
The framing effect is only seen with money
False
This framing effect is not just seen with money
Describe Tversky and Kahneman’s (1981) experiment involving a humanitarian problem phrased as a gain/save to investigate the framing effect
List 2 points
- Presented Ps with the following problem:
“Imagine that the US is preparing for an outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed…
If program A is adopted, 200 people will be saved
If program B is adopted, there is 1/3 probability that 600 people will be saved and 2/3 probability that no people will be saved”
- Ps had to choose one option
Tversky and Kahneman (1981):
- Presented Ps with the following problem:
“Imagine that the US is preparing for an outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed…
If program A is adopted, 200 people will be saved
If program B is adopted, there is 1/3 probability that 600 people will be saved and 2/3 probability that no people will be saved”
- Ps had to choose one option
Which option did the majority choose? and what % of people choose that option?
72% chose program A, the “safe” program
Describe Tversky and Kahneman’s (1981) experiment involving a humanitarian problem rephrased as a loss to investigate the framing effect
List 2 points
- Presented Ps with the following problem:
If program A is adopted, 400 people will die
If program B is adopted, there is 1/3 probability that nobody will die and 2/3 probability that 600 people will die
- Ps had to choose one option
Tversky and Kahneman (1981):
- Presented Ps with the following problem:
If program A is adopted, 400 people will die
If program B is adopted, there is 1/3 probability that nobody will die and 2/3 probability that 600 people will die
- Ps had to choose one option
Which option did the majority choose? and what % of people choose that option?
78% chose option B, the “risky” option B
Framing identical final outcomes as gains or losses has caused a preference reversal, consistent with the idea that there is …?
An S-shaped value function centred on a reference point
Framing identical final outcomes as gains or losses has caused a …?
Preference reversal
One other feature of the S-shaped value function proposed by Prospect Theory is that it is steeper in the ______ than it is for ______
a. Gains, Loss
b. Loss, Gains
b. Loss, Gains
One other feature of the S-shaped value function posited by Prospect Theory is that it is ______ in the loss-domain than it is for gains
a. Steeper
b. Shallower
a. Steeper
One other feature of the S-shaped value function posited by Prospect Theory is that it is steeper in the loss-domain than it is for gains – typically, it’s assumed to be about _____ as steep.
a. 3x
b. 2x
c. 6x
d. 4x
b. 2x
One other feature of the S-shaped value function posited by Prospect Theory is that it is steeper in the loss-domain than it is for gains – typically, it’s assumed to be about twice as steep
What does this reflect?
“Losses loom larger than gains”
Simply = A loss of a given magnitude has greater subjective magnitude than a gain of the same size
According to the prospect theory, a loss of a given magnitude has ______ subjective magnitude than a gain of the same size
a. Greater
b. Smaller
a. Greater
When asked:
“Would you take a bet that offered a 50% chance of winning £1000 and a 50% chance of losing £1000?”
Most people say “no”
Is this…?
a. Loss seeking
b. Gain seeking
c. Gain aversion
d. Loss aversion
d. Loss aversion
Name one putative demonstration of loss aversion
Endowment effect
What is the endowment effect?
When people value an item they already own more than they would be prepared to pay for the same item if they did not own it
When people value an item they already own more than they would be prepared to pay for the same item if they did not own it
This is known as…?
The endowment effect
Describe Knetsch’s (1989) study on the endowment effect
List 4 points
- Students were given a choice between a 400g bar of Swiss chocolate and
a new coffee mug - Group 1 = Ps simply indicated which product they would like to take (no initial
endowment) - Group 2 = Ps were given (endowed with) the mug and had it in their possession for a few minutes before being asked whether they would like to swap it for the chocolate bar
- Group 3 = Ps were given the chocolate bar and later asked whether they would like to swap it for the mug
Knetsch’s (1989) study involved:
- Students were given a choice between a 400g bar of Swiss chocolate and
a new coffee mug - Group 1 = Ps simply indicated which product they would like to take (no initial
endowment)
What did the majority choose in group 1? and what %?
Choosing to take the mug and chocolate bar was evenly spread when there was no initial endowment
Mug = 56%
Chocolate = 44%
Knetsch’s (1989) study involved:
- Students were given a choice between a 400g bar of Swiss chocolate and
a new coffee mug - Group 2 = Ps were given (endowed with) the mug and had it in their possession for a few minutes before being asked whether they would like to swap it for the chocolate bar
What did the majority choose in group 2? and what %?
The majority chose to keep the mug that they had rather than swap for a chocolate bar when endowed with the mug
Mug = 89%
Chocolate = 11%
Knetsch’s (1989) study involved:
- Students were given a choice between a 400g bar of Swiss chocolate and
a new coffee mug - Group 3 = Ps were given the chocolate bar and later asked whether they would like to swap it for the mug
What did the majority choose in group 3? and what %?
The majority chose to keep the chocolate bar that they had rather than swap for a mug when endowed with the chocolate bar
Mug = 10%
Chocolate = 90%
When given the option to swap or keep the chocolate bar for a mug, Ps who were endowed with the chocolate bar chose to …?
a. Keep the chocolate bar
b. Swap for the mug
c. Neither
d. Both
a. Keep the chocolate bar
When given the option to swap or keep the mug for a chocolate bar, Ps who were endowed with the mug chose to …?
a. Swap the chocolate bar
b. Keep the mug
c. Neither
d. Both
b. Keep the mug
True or False?
According to the endowment effect, once the object is in
people’s possession, they are willing to swap it
According to the endowment effect, once the object is in
people’s possession, they are reluctant to swap it
Is the endowment effect universal?
No
Economists often argue that endowment effects are …?
Rational or Artefactual
Economists often argue that endowment effects are rational or artefactual
Why?
There may be a “transaction cost” associated with the effort of making an exchange
Similarly, when people are asked to state their “buying price” (willingness to pay) or “selling price” (willingness to accept), they may not respond honestly, or may misunderstand how the market works
There is evidence that the endowment effect doesn’t arise in some situations
Give one example
In domains where the buyers and sellers have considerable market experience
True or False?
Loss aversion is a universal feature of decision-making
False
Loss aversion is not a universal feature of decision-making
What does loss aversion depend on? List 3 things
- The probabilities and amounts involved
- Past experience with other gambles
- The framing of the task
- The probabilities and amounts involved
- Past experience with other gambles
- The framing of the task
These are the 3 factors that affect…?
Loss aversion
True or False?
The endowment effect is argued to be irrational and a hindrance to the proper operation of markets
True
This endowment effect is argued to be irrational and a hindrance to the proper operation of markets.
It is often taken to be evidence for …?
A steeper value function for losses than for gains
e.g. Once you’ve got the mug (or chocolate), giving it up seems like a loss and acquiring the other product seems like a gain, and the value function means that “losses loom larger than gains”
According to the endowment effect, there is a steeper value function for ______ than for _____
a. Losses, Gains
b. Gains, Losses
a. Losses, Gains
Describe Tversky and Kahneman’s (1981) study on the certainty effect when options were framed as gains
- Ps were asked to choose between:
A. A 50% chance to win a tour of England, France, and Italy
B. A one week tour of England, with certainty
What is the certainty effect?
When people disproportionately weight outcomes which are guaranteed to occur (or not occur) so that “a reduction of the probability of an outcome by a constant factor has more impact when the outcome was initially certain than when it was merely probable”
Simply = The tendency of people to feel disproportionately better about outcomes that are certain compared to outcomes that are probable or possible
When people disproportionately weight outcomes which are guaranteed to occur (or not occur) so that “a reduction of the probability of an outcome by a constant factor has more impact when the outcome was initially certain than when it was merely probable”
Simply = The tendency of people to feel disproportionately better about outcomes that are certain compared to outcomes that are probable or possible
This is known as…?
Certainty effect
In Tversky and Kahneman’s (1981) study:
- Ps were asked to choose between:
A. A 50% chance to win a tour of England, France, and Italy
B. A one week tour of England, with certainty
What option did the majority choose? And what %?
78% chose option B, the certain option
From an expected utility perspective, this implies that 0.5 x u(England, France, Italy) is less than u(England)
i.e., that the utility of a trip to England, France, and Italy is less than twice the utility of a trip to England alone.
Describe Tversky and Kahneman’s (1981) study on the certainty effect when options were framed as losses
- Ps were asked to choose between:
C. A 5% chance to win a tour of England, France, and Italy
D. A 10% chance to win a tour of England
- Ps were asked to choose between:
C. A 5% chance to win a tour of England, France, and Italy
D. A 10% chance to win a tour of England
What option did the majority choose? And what %?
67% chose option C, the probability option
From an expected utility perspective, which implies that 0.05 x u(England, France, and Italy) > 0.1 x u(England).
i.e, u(England, France, Italy) is now more than twice the utility of a trip to England alone
Changes in probability will have a much bigger impact when …?
They approach certainty (0% or 100%)
Describe the study by Gonzalez and Wu (1999) investigating non-linear probabilities when the probability is small
List 2 points
- Ps were presented with:
“You have two lotteries to win $250. One offers a 5% chance to win the prize and the other offers a 30% chance to win the prize.
- Ps were given 2 options and were asked “Which of these two improvements, or increases, seems like a more significant change?”:
Option A: You can improve the chances of winning the first lottery from 5 to 10%
Option B: You can improve the chances of winning the second lottery from 30 to 35%.
In a study by Gonzalez and Wu (1999):
- Ps were presented with:
“You have two lotteries to win $250. One offers a 5% chance to win the prize and the other offers a 30% chance to win the prize.
- Ps were given 2 options and were asked “Which of these two improvements, or increases, seems like a more significant change?”:
Option A: You can improve the chances of winning the first lottery from 5 to 10%
Option B: You can improve the chances of winning the second lottery from 30 to 35%.
What option did the majority choose? And what %?
75% chose option A
Describe the study by Gonzalez and Wu (1999) investigating non-linear probabilities when the probability is large
List 2 points
- Ps were presented with:
“You have two lotteries to win $250. One offers a 65% chance to win the prize and the other offers a 90% chance to win the prize.”
- Ps were given 2 options and were asked “Which of these two improvements, or increases, seems like a more significant change?”:
Option C: You can improve the chances of winning the first lottery from 65 to 70%.
Option D: You can improve the chances of winning the second lottery from 90 to 95%.
In a study by Gonzalez and Wu (1999):
- Ps were presented with:
“You have two lotteries to win $250. One offers a 65% chance to win the prize and the other offers a 90% chance to win the prize.”
- Ps were given 2 options and were asked “Which of these two improvements, or increases, seems like a more significant change?”:
Option C: You can improve the chances of winning the first lottery from 65 to 70%.
Option D: You can improve the chances of winning the second lottery from 90 to 95%.
What option did the majority choose? And what %?
63% chose option D
True or False?
An increase from 5% to 10% felt less important than the same absolute increment in the mid-range of probabilities like 30% to 35%
False
An increase from 5% to 10% felt more important than the same absolute increment in the mid-range of probabilities like 30% to 35%
True or False?
An increase from 90% to 95% felt less important than an increase from 65% to 70%
False
An increase from 90% to 95% felt more important than an increase from 65% to 70%
An increase from 90% to 95% felt _____ important than an increase from 65% to 70%
a. Less
b. More
b. More
An increase from 5% to 10% felt _____ important than the same absolute increment in the mid-range of probabilities like 30% to 35%
a. Less
b. More
b. More
What is a decision weight function?
A non-linear mapping between stated probabilities and the weight given to the corresponding outcome when forming an overall evaluation of a prospect
Simply = Small probability events receive more weight than they should, based on their likelihood of occurrence, while large probabilities receive too little weight
A non-linear mapping between stated probabilities and the weight given to the corresponding outcome when forming an overall evaluation of a prospect
This is known as…?
Decision weight function
True or False?
Decision weight function is the same as positing a mapping between physical probabilities and the subjective representation of how a given probability “feels”, subjectively
False
Decision weight function is the same as positing a mapping between physical probabilities and the subjective representation of how a given probability “feels”, subjectively
In the expected utility theory, utilities are weighted by …?
The probability of each outcome
Whose “paradox” was an early problem for Expected Utility theory?
Allais
In the expected utility theory, utilities are weighted by the probability of each outcome.
Is this tenable?
Extensive violations of rationality suggest not
Describe Kahneman and Tversky’s (1979) study on decision weights function
List 3 points
- Ps were presented with 2 problems
- Problem 1 = Ps were given 2 options and were asked to choose one
Option A:
- $2500 with probability of 0.33
- $2400 with probability of 0.66
- $0 with probability of 0.01
Option B:
- $2500 with certainity
- Problem 2 = Ps were given 2 options and were asked to choose one
Option C:
- $2500 with probability of 0.33
- $0 with probability of 0.67
Option D:
- $2400 with probability of 0.34
- $0 with probability of 0.66
In Kahneman and Tversky’s (1979) study:
- Ps were presented with 2 problems
- Problem 1 = Ps were given 2 options and were asked to choose one
Option A:
- $2500 with probability of 0.33
- $2400 with probability of 0.66
- $0 with probability of 0.01
Option B:
- $2500 with certainty
What option did the majority choose? And what %?
82% chose option B
In Kahneman and Tversky’s (1979) study:
- Ps were presented with 2 problems
- Problem 2 = Ps were given 2 options and were asked to choose one
Option C:
- $2500 with probability of 0.33
- $0 with probability of 0.67
Option D:
- $2400 with probability of 0.34
- $0 with probability of 0.66
What option did the majority choose? And what %?
83% chose option C
True or False?
People underestimate small probability but overestimate big probability
False
People overestimate low/small probability but underestimate high/big probability
According to the prospect theory people have a hard time evaluating probability accurately, and in most cases, they tend to _______ the likelihood of low-probability events
a. Overestimate
b. Underestimate
a. Overestimate
According to the prospect theory people have a hard time evaluating probability accurately, and in most cases, they tend to ________ the likelihood of high-probability events
a. Overestimate
b. Underestimate
b. Underestimate
The prospect theory involves 4 core components
What are they?
- Editing stage
- Reference point
- Value function
- Decision weights
Prospect Theory was proposed by Kahneman and Tversky (1979) as a descriptive account of …?
Human decisions under risk
What is the editing stage of the prospect theory?
When a number of principles are used to simplify the options and ready them for evaluation
e.g., if a gamble promised a 50% chance of £10, a 10% chance of £10, and a 40% chance of nothing, the first two options will be combined into a single “60% chance of £10” representation
Similarly, inconsequential differences in amounts will be ignored (“rounded”)
Prospect Theory was proposed by …?
Kahneman and Tversky (1979)
What is the reference point stage of the prospect theory?
A reference point is selected
It determines whether outcomes are construed as gains or losses, with the value of these outcomes being determined by the S-shaped value function
What is the value function stage of the prospect theory?
When the subjective value of outcomes are multiplied by the decision-weight transformations of their associated probabilities
When a number of principles are used to simplify the options and ready them for evaluation
Which stage of the prospect theory is this?
a. Editing stage
b. Reference point
c. Value function
d. Decision weights
a. Editing stage
When the subjective value of outcomes are multiplied by the decision-weight transformations of their associated probabilities
Which stage of the prospect theory is this?
a. Editing stage
b. Reference point
c. Value function
d. Decision weights
c. Value function
It determines whether outcomes are construed as gains or losses, with the value of these outcomes being determined by the S-shaped value function
Which stage of the prospect theory is this?
a. Editing stage
b. Reference point
c. Value function
d. Decision weights
b. Reference point
What is the decision weight stage of the prospect theory?
The overall value of a prospect (gamble) is then: w(p1)v(a1) + w(p2)+v(a2) + …
w is the decision-weight function, v is the value function, and p1 and a1 are the probabilities and amounts for each outcome
The overall value of a prospect (gamble) is then: w(p1)v(a1) + w(p2)+v(a2) + …
Which stage of the prospect theory is this?
a. Editing stage
b. Reference point
c. Value function
d. Decision weights
d. Decision weights
If a gamble promised a 50% chance of £10, a 10% chance of £10, and a 40% chance of nothing, the first two options will be combined into a single “60% chance of £10” representation
Similarly, inconsequential differences in amounts will be ignored (“rounded”)
Which stage of the prospect theory is this?
a. Editing stage
b. Reference point
c. Value function
d. Decision weights
a. Editing stage
The overall value of a prospect (gamble) is …?
w(p1)v(a1) + w(p2)+v(a2) + …
w = decision-weight function, v = value function
p1 and a1 = probabilities and amounts for each outcome
The original version of Prospect Theory (Kahneman & Tversky, 1979) had a number of limitations
What are the 2 main limitations?
- Limited scope
- Purely descriptive
The prospect theory was limited to gambles with only two outcomes
Which theory addressed some of the problems with the prospect theory?
Cumulative Prospect Theory (Tversky & Kahneman, 1992)
Who proposed the Cumulative Prospect Theory?
Tversky & Kahneman (1992)
One problem with the prospect theory is Limited Scope
There are violations of rationality in risky choice which Prospect Theory doesn’t address
What are they?
- Valuation vs Choice
- Attraction effect
True or False?
People have stable
psychoeconomic functions that map objective quantities (e.g., amounts of money) onto patterns of behaviour.
False
People do not have stable
psychoeconomic functions that map objective quantities (e.g., amounts of money) onto patterns of behaviour.
- Valuation vs Choice
- Attraction effect
What do both of these have in common?
They relate to the idea that people do not have stable
psychoeconomic functions that map objective quantities (e.g., amounts of money) onto patterns of behaviour
- Valuation vs Choice
- Attraction effect
These are limited scope problems related to…?
a. Prospect theory
b. Expected value theory
c. Expected utility theory
d. Randomisation theory
a. Prospect theory
When people’s valuations of two gambles can contradict their choices when asked to pick between them
This is known as…?
Valuation vs Choice
What is Valuation vs Choice?
When people’s valuations of two gambles can contradict their choices when asked to pick between them
Describe Lichtenstein and Slovic’s (1971) study on Valuation vs Choice
List 3 points
- Ps were presented with pairs of bets and indicated which they would prefer
to play:
Option “P bet”: A high probability of winning a relatively small amount.
e.g., a 95% chance to win $2.50 and a 5% chance to lose $0.75
Option “$ bet”: A small chance of winning a large amount of money
e.g., a 40% chance of winning $8.50 and a 60% chance of losing $1.50
- 1 hour after completing this choice task, Ps were shown the bets one at a time, told that they owned a ticket entitling them to play the gamble
- Ps were asked to state the minimum price for which they would be prepared to sell the ticket (they
were asked to express in dollars how much the bet was worth to them)
In Lichtenstein and Slovic’s (1971) study:
- Ps were presented with pairs of bets and indicated which they would prefer
to play:
Option “P bet”: A high probability of winning a relatively small amount.
e.g., a 95% chance to win $2.50 and a 5% chance to lose $0.75
Option “$ bet”: A small chance of winning a large amount of money
e.g., a 40% chance of winning $8.50 and a 60% chance of losing $1.50
- 1 hour after completing this choice task, Ps were shown the bets one at a time, told that they owned a ticket entitling them to play the gamble
- Ps were asked to state the minimum price for which they would be prepared to sell the ticket (they
were asked to express in dollars how much the bet was worth to them)
What were the results? (List 4 things)
- On average, P-bets and $-bets were chosen about equally often
- Ps showed preference reversals
e.g. They gave a higher valuation for the $-bet than for the corresponding P-bet, even though they chose the P-bet in the choice-task.
- 73% showed this reversal for every pair where they originally chose the P-bet
- By contrast, hardly anyone showed a reversal in the other direction (offering a higher valuation for the P-bet when the $-bet had originally been chosen; only 17% of people ever did this)
In Lichtenstein and Slovic’s (1971) study:
- Ps were presented with pairs of bets and indicated which they would prefer
to play:
Option “P bet”: A high probability of winning a relatively small amount.
e.g., a 95% chance to win $2.50 and a 5% chance to lose $0.75
Option “$ bet”: A small chance of winning a large amount of money
e.g., a 40% chance of winning $8.50 and a 60% chance of losing $1.50
- 1 hour after completing this choice task, Ps were shown the bets one at a time, told that they owned a ticket entitling them to play the gamble
- Ps were asked to state the minimum price for which they would be prepared to sell the ticket (they
were asked to express in dollars how much the bet was worth to them)
What % of people who choose the P-bet sell the $-bet for a higher price?
73%
In Lichtenstein and Slovic’s (1971) study:
- Ps were presented with pairs of bets and indicated which they would prefer
to play:
Option “P bet”: A high probability of winning a relatively small amount.
e.g., a 95% chance to win $2.50 and a 5% chance to lose $0.75
Option “$ bet”: A small chance of winning a large amount of money
e.g., a 40% chance of winning $8.50 and a 60% chance of losing $1.50
- 1 hour after completing this choice task, Ps were shown the bets one at a time, told that they owned a ticket entitling them to play the gamble
- Ps were asked to state the minimum price for which they would be prepared to sell the ticket (they
were asked to express in dollars how much the bet was worth to them)
What % of people who choose the $-bet sell the P-bet for a higher price?
17%
Ps showed preference reversals
e.g. They gave a higher valuation for the $-bet than for the corresponding P-bet, even though they chose the P-bet in the choice-task.
73% showed this reversal for every pair where they originally chose the P-bet
What does this suggest about how preferences are constructed?
List 2 points
- Preferences are constructed by elicitation procedures rather than reflected in people’s responses in those tasks
Simply = You construct a preference based on the way in which the question is presented to you
- They imply that there is no stable value function relating objective and subjective value
Preferences are constructed by elicitation procedures rather than reflected in people’s responses in those tasks
They imply that there is no stable value function relating objective and subjective value
Simply = You construct a preference based on the way in which the question is presented to you
What is one explaination for this effect?
Response compatibility
How does response compatibility work?
In the valuation task, responses are on the same scale as the rewards/losses offered by the bet so that aspect of the gamble will dominate
$-bets are valued more highly than P-bets (because the monetary returns are greater)
Which bets are valued more than the other?
a. Probability > Monetary
b. Monetary > Probability
c. None
b. Monetary > Probability
Monetary-bets are valued more highly than Probability-bets
Why?
Because the monetary returns are greater than probability returns
True or False?
There is a stable value function relating objective and subjective value
False
They imply that there is no stable value function relating objective and subjective value
You construct a preference based on the way in which the question is presented to you
Can the prospect theory account for this?
No
What is the context/decoy effect?
When we add in an option that is irrelevant but it changes the context of the decision (menu of options available to you)
You value the other options differently than if the added option wasn’t there
When we add in an option that is irrelevant but it changes the context of the decision (menu of options available to you)
You value the other options differently than if the added option wasn’t there
This is known as…?
The context effect
or
The decoy effect
What is the asymmetric dominance effect also known as…?
The attraction effect
Describe the study by Ariely (2009) on the asymmetric dominance effect (aka the attraction effect)
List 4 points
- Ps were shown a genuine advert in the Economist magazine offering:
Option A. One-year on-line only subscription. $59.
Option B. One-year print subscription. $125
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
- Ps were then shown only 2 options:
Option A. One-year on-line only subscription. $59.
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
In a study by Ariely (2009):
- Ps were shown a genuine advert in the Economist magazine offering:
Option A. One-year on-line only subscription. $59.
Option B. One-year print subscription. $125
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
- Ps were then shown only 2 options:
Option A. One-year on-line only subscription. $59.
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
What % of people chose option A when there were Options A, B and C available?
16%
In a study by Ariely (2009):
- Ps were shown a genuine advert in the Economist magazine offering:
Option A. One-year on-line only subscription. $59.
Option B. One-year print subscription. $125
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
- Ps were then shown only 2 options:
Option A. One-year on-line only subscription. $59.
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
What % of people chose option B when there were Options A, B and C available?
0%
In a study by Ariely (2009):
- Ps were shown a genuine advert in the Economist magazine offering:
Option A. One-year on-line only subscription. $59.
Option B. One-year print subscription. $125
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
- Ps were then shown only 2 options:
Option A. One-year on-line only subscription. $59.
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
What % of people chose option C when there were Options A, B and C available?
84%
In a study by Ariely (2009):
- Ps were shown a genuine advert in the Economist magazine offering:
Option A. One-year on-line only subscription. $59.
Option B. One-year print subscription. $125
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
- Ps were then shown only 2 options:
Option A. One-year on-line only subscription. $59.
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
What % of people chose option A when there were only Options A and C available?
68%
In a study by Ariely (2009):
- Ps were shown a genuine advert in the Economist magazine offering:
Option A. One-year on-line only subscription. $59.
Option B. One-year print subscription. $125
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
- Ps were then shown only 2 options:
Option A. One-year on-line only subscription. $59.
Option C. One year print and web subscription. $125
- Ps were asked to choose which option they preferred
What % of people chose option C when there were only Options A and C available?
32%
What did the results in Ariely’s (2009) decoy effect study demonstrate?
List 2 points
- Asymmetric dominance effect (aka the attraction effect)
- Violates a core assumption of conventional rational choice theory – namely, the independence from irrelevant alternatives
What is the conventional rational choice theory?
Individuals rely on rational calculations to make rational choices that result in outcomes aligned with their own best interests
Individuals rely on rational calculations to make rational choices that result in outcomes aligned with their own best interests
This is known as…?
The conventional rational choice theory
What is the independence from irrelevant alternatives (conventional rational choice theory)?
When decisions results should not change if an unfavourable option is left out
e.g. My preference between two options should not depend on other options.
After all, whether I prefer an apple to an orange shouldn’t depend on whether I had the option of choosing a banana
When decisions results should not change if an unfavourable option is left out
e.g. My preference between two options should not depend on other options.
After all, whether I prefer an apple to an orange shouldn’t depend on whether I had the option of choosing a banana
This is known as…?
The independence from irrelevant alternatives (conventional rational choice theory)
True or False?
The asymmetric dominance effect also shapes risky choice
True
After all, whether I prefer an apple to an orange shouldn’t depend on whether I had the option of choosing a banana
This is an example of…?
The independence from irrelevant alternatives (conventional rational choice theory)
Describe Wedell’s (1991) study on the asymmetric dominance effect (attraction effect) in shaping risky choices
List 4 points
- Ps were presented with 2 choices:
A relatively safe option = “A 50% chance of $20”
A relatively risky option = “A 30% chance of £33”.
- Ps were asked to choose which option they preferred
- Ps were then presented with 3 choices:
A relatively safe option = “A 50% chance of $20”
A relatively risky option = “A 30% chance of £33”.
An asymmetrically-dominated decoy = “A 25% chance of $33”
or
Another decoy = “A 50% chance of $18”
- Ps were asked to choose which option they preferred
A relatively safe option = “A 50% chance of $20”
A relatively risky option = “A 30% chance of £33”.
Which decoy is most likely to boost the preference for the safer option?
a. “A 25% chance of $33”
b. “A 50% chance of $18”
b. “A 50% chance of $18”
A relatively safe option = “A 50% chance of $20”
A relatively risky option = “A 30% chance of £33”.
Which decoy is most likely to boost the preference for the riskier option?
a. “A 25% chance of $33”
b. “A 50% chance of $18”
a. “A 25% chance of $33”
What is the similarity effect?
When the decoy is similar to option A it draws choice share from A and boosts relative preference for B
When the decoy is similar to option A it draws choice share from A and boosts relative preference for B
This is known as…?
The similarity effect
What is the compromise effect?
When the decoy is more extreme than option A on both dimensions, it boosts choice share for A
When the decoy is more extreme than option A on both dimensions, it boosts choice share for A
This is known as…?
The compromise effect
What are the 3 types of decoy effects?
- The attraction effect (asymmetric dominance effect)
- The similarity effect
- The compromise effect
Explain the reason behind the attraction effect (asymmetric dominance effect) in the Economist experiment by Ariely (2009)
List 3 points
- Relative judgment
- The target item (e.g., the print+online package) is clearly equal to or better than the decoy (print only) option on both relevant dimensions (price and quantity; it costs more but you get the same)
- The online-only version only “beats” the decoy on one dimension (affordability)
So these comparisons lead to selection of the target (for example, because it has higher “rank position” in the set of three, or because it is easier to justify the choice of this item)
True or False?
Context effects aren’t
captured by Prospect Theory
True
Describe the study by Weber and Chapman (2005) on how risky choice contradict the prospect theory
List 2 points
- Ps were presented with 4 probabilities of outcomes and 4 different sizes of stakes:
Low probabilities + Low stakes = A 2% chance of $6 or A 4% chance of $3
Low probabilities + High stakes = A 2% chance of $600 or A 4% chance of $300
High probabilities + Low stakes = A 40% chance of $6 or An 80% chance of $3
High probabilities + High stakes = A 40% chance of $600 or An 80% chance of $300
- Ps were asked to choose the option they prefer
In Weber and Chapman’s (2005) study:
- Ps were presented with 4 probabilities of outcomes and 4 different sizes of stakes:
Low probabilities + Low stakes = A 2% chance of $6 or A 4% chance of $3
Low probabilities + High stakes = A 2% chance of $600 or A 4% chance of $300
High probabilities + Low stakes = A 40% chance of $6 or An 80% chance of $3
High probabilities + High stakes = A 40% chance of $600 or An 80% chance of $300
- Ps were asked to choose the option they prefer
What were the results?
When the outcomes have high probabilities, Ps are less risk-averse when the stakes are low
(peanuts effect: people don’t mind taking a risk when playing for peanuts)
What is the peanuts effect?
When the outcomes have high probabilities, Ps are less risk-averse when the stakes are low
People don’t mind taking a risk when playing for peanuts
When the outcomes have high probabilities, Ps are less risk-averse when the stakes are low
This is known as…?
The peanuts effect
According to the peanuts effect, when the outcomes have high probabilities, Ps are ______ risk-averse when the stakes are low
a. Less
b. More
a. Less
The peanuts effect can be explained by …?
The value function of Prospect Theory
How can the peanuts effect be explained by the value function of Prospect Theory?
Refer to this context:
Low probabilities + Low stakes = A 2% chance of $6 or A 4% chance of $3
Low probabilities + High stakes = A 2% chance of $600 or A 4% chance of $300
High probabilities + Low stakes = A 40% chance of $6 or An 80% chance of $3
High probabilities + High stakes = A 40% chance of $600 or An 80% chance of $300
The subjective difference between $6 and $3 may seem bigger than the difference between $600 and $300, so it seems more worth taking a gamble in the low-stakes case.
True or False?
The subjective difference between $6 and $3 may seem smaller than the difference between $600 and $300, so it seems more worth taking a gamble in the high-stakes case.
False
The subjective difference between $6 and $3 may seem bigger than the difference between $600 and $300, so it seems more worth taking a gamble in the low-stakes case.
The peanuts effect is much smaller (nee, non-existent) when the probabilities are ____
a. Large
b. Medium
c. Small
c. Small
The peanuts effect is much larger when the probabilities are ____
a. Large
b. Medium
c. Small
a. Large
Why can’t the prospect theory accommodate for the peanuts effect?
List 2 points
- We’d have to assume that the value function is less concave when the probabilities are low
- But it doesn’t really make sense to posit that the subjective value of a particular amount of money depends on the probability of receiving it
What are the 3 most praised ideas about the prospect theory?
- Reference-point-dependent valuations
- Diminishing sensitivity to gains and losses
- Non-linear transformations of probabilities into subjective “weights”
Describe Wedell’s (1991) study the attraction effect
List 4 points
- Ps were presented with 3 options
Option A = 40% chance of $25
Option B = 30% chance of $33
Option C = 40% chance of $20
- Ps were asked to choose their preferred option
- Ps were then presented with 3 other options
Option A = 40% chance of $25
Option B = 30% chance of $33
Option C = 25% chance of $33
- Ps were asked to choose their preferred option
In Wedell’s (1991) study:
- Ps were presented with 3 options
Option A = 40% chance of $25
Option B = 30% chance of $33
Option C = 40% chance of $20
- Ps were asked to choose their preferred option
Which option did the majority choose? And what %?
60% chose option A
In Wedell’s (1991) study:
- Ps were then presented with 3 other options
Option A = 40% chance of $25
Option B = 30% chance of $33
Option C = 25% chance of $33
- Ps were asked to choose their preferred option
Which option did the majority choose? And what %?
75% chose option B
The presence of the “irrelevant” or “unfavourable” option impacts decision making
This is known as…?
Context effect
or
Decoy effect
Prospect theory is…?
a. Quantitative
b. Experimental
c. Descriptive
d. Quasi
c. Descriptive
What is the parallel problem with the prospect theory?
It is purely descriptive
A parallel problem is that Prospect Theory is purely descriptive
What does this mean?
Decisions will be “as if” people combine amounts and probabilities in a particular way, but makes no claims or predictions about the actual processes by which people reach a decision
Decisions will be “as if” people combine amounts and probabilities in a particular way, but makes no claims or predictions about the actual processes by which people reach a decision
Does this apply to…?
a. Expected value theory
b. Irrational theory
c. Expected utility theory
d. Prospect theory
d. Prospect theory
More recent theories have specified process accounts of the sampling, integration, and comparison processes that underlie risky choice
Give one example
Stewart et al.’s (2006) = Decision by Sampling account
What is the Decision by Sampling account suggest?
Emphasises the role of memory retrieval in constructing subjective value
A given amount of money, will be valued by retrieving other amounts of money from memory and performing pairwise comparisons against the target value to establish the target’s rank-position in the set
Emphasises the role of memory retrieval in constructing subjective value
This is known as…?
Decision by Sampling account
A given amount of money, will be valued by retrieving other amounts of money from memory and performing pairwise comparisons against the target value to establish the target’s rank-position in the set
This is an example of…?
Decision by Sampling account
What does the Decision by Sampling account predict?
That subjective values, and choices, will depend upon the memory-retrieval set against which the current attribute is compared
Simply = Choices are influenced by the memories or past experiences one uses as a basis for comparison.
The memories retrieved play a role in shaping current preferences and decisions.
What predicts that:
That subjective values, and choices, will depend upon the memory-retrieval set against which the current attribute is compared
Simply = Choices are influenced by the memories or past experiences one uses as a basis for comparison.
The memories retrieved play a role in shaping current preferences and decisions.
Decision by Sampling account
According to the Decision by Sampling account, we should be able to shift people’s preferences by …?
Exposing them to different amounts of money (or probabilities) earlier in the session
True or False?
Decisions and choices are often “rational”
False
Decisions and choices are often “irrational”
Prospect theory explains these effects (irrational decision making) by invoking …?
List 3 things
- Reference points
- The value function
- Probability weighting
The prospect theory is descriptive
What does this mean?
The theory only describes the choices that people make
It tells us nothing about the psychology/mechanisms inside your head that might lead to those decisions
When you’re considering how much a value is worth to you, you take a sample from your working memory and you see where it ranks in that sample
If it ranks highly it’s going to feel like a lot money, if it ranks low, it’s going to feel like a small amount of money
This is known as…?
Decision by Sampling
How can Decision by Sampling be the mechanism to explain decision making in the economic world?
If you sample from memory and seeing if whether the value you’re considering ranks in that sample and then applying that in the economic environment we all live in, we will get the S-curve
True or False?
Losing $500 is ranked much lower in terms of badness than gaining $500 would in terms of goodness
False
Losing $500 is ranked much higher in terms of badness than gaining $500 would in terms of goodness
What kind of theory is the Decision by Sampling account?
Process theory
How does the Decision by Sampling account explain the descriptions made by the prospect theory?
The account asks what are the cognitive mechanisms going on when you’re making a decision and apply the cognitive process in the environment that we happen to live in
We are able to understand better why those curves take the shape they do (why there is an S-shape in decision making, as demonstrated in the prospect theory)
