Decisions

Question 1

Belief-Desire Psychology

Answer 1

hoices are based on
Beliefs – about how the world is and what the outcomes of actions might be
Desires – what the person making the choice likes or wants to happen

Question 2

(Subjective)(Expected)Utility Theory

Answer 2

You should make choices that have the highest utility (subjective value) for you
For a choice between objects (cars, textbooks, etc.) each object has multiple attributes, some of which are more important than others

Question 3

Choices among actions

Answer 3

Here there may be different possible outcomes following the same action (shares are bought, but their value may go up or down; a night at the club may be good or bad)
To calculate the average (or expected) utility, each outcome must be weighted by its probability (which may be objective or subjective)

Question 4

Prospect Theory

Answer 4

Prospect Theory (Kahneman and Tversky) is a major example of such a theory, which has been highly influential in the founding and development of behavioural economics
Outcomes should be defined in terms of gains and losses (changes from the status quo) not in terms of absolute utility levels

Question 5

Consequences and Origin of Loss Aversion

Answer 5

Loss aversion can make some kinds of bargaining difficult. Concessions on one side are losses, which loom larger, but to the other side they are gains that loom less large

Loss aversion may have an evolutionary explanation – severe loss leads to inability to pass on genes

Question 6

1. The Endowment Effect

Answer 6

The effect of “ownership”
‘This pattern—the fact that people often demand much more to give up an object than they would be willing to pay to acquire it—is called theendowment effect(Thaler, 1980).’

Question 7

2. Probabilities

Answer 7

Does a 5% increase in (say) the probability of winning £1M always have the same effect?
Utility theory says it should
Compare
0% vs 5% chance of winning (the probability effect)
5% vs 10% chance
60% vs 65% chance
95% vs 100% (the certainty effect)

These increases are not psychologically the same

Question 8

3. Allais Paradox

Answer 8

The Allais Paradox arises because, when people make choices between individual gambles, their choices cannot be reconciled (within the framework of utility theory) with their choices between more complex gambles, which, although it is not immediately apparent, are just combinations of the simple gambles
Prospect theory explains away the paradox because, when the gambles are combined, the probabilities of the outcomes move along the (distorted) value scale

Question 9

4. Mental Accounting 
Tversky and Kahneman (1981)

Answer 9

Result can be explained by assuming we allocate resources to different “accounts” and reason about gains and losses within particular accounts

Question 10

5. Framing

Answer 10

Two treatment for lung cancer: radiation, surgery
Surgery riskier in short term, but better in long term

The one month survival rate for surgery is 90%
There is 10% mortality in first month

84% vs 50% of physicians said they would favour surgery, given these two descriptions of the outcome