Human Decision Making Flashcards
An Overview
- Prospect Theory and
Human Choice Biases & Deficiencies - (Consumer) Decision Making Process
- Purchase Funnel – Classic and New Perspectives
Prospect Theory and
Human Choice Biases & Deficiencies
Prospect Theory (Kahneman & Tversky 1979)
- Seminal Paper in Behavioral Economics
- One of the most important theories of consumer behavior
- Reference point – People ‘anchor’
- Gains and losses are only with respect to the reference point
- Consumers respond to changes
Theory
* Losses loom larger than gains
* Loss aversion is much larger
* Even if L = G: VL»_space; VG
- Research shows most firms may work
the other way around:
Overestimating response to gains
Underestimating response to losses
Key Features
Loss Aversion: People dislike losses more than equivalent gains, leading to risk aversion in choices involving sure gains and risk seeking in choices involving sure losses.
Certainty Effect: The tendency to prefer certain outcomes over uncertain ones, even if the expected value is the same.
Framing Effects: The way information is presented (framed) influences decision-making, with different frames leading to different choices.
Non-Linear Weights: Probabilities are not weighted linearly, with more weight given to extreme outcomes (e.g., 0% or 100% chance).
Reference Point: Decisions are made relative to a reference point (e.g., current wealth), rather than absolute outcomes.
Implications
Implications
Risk Aversion: Prospect Theory explains why people tend to avoid risks, even if the expected outcome is favorable.
Mental Accounting: The tendency to separate financial transactions into separate accounts (e.g., “fun money” vs. “serious money”), leading to inconsistent decisions.
Anchoring Bias: The tendency to rely too heavily on the first piece of information encountered, influencing subsequent decisions.
Applications:
Economics: Prospect Theory has been applied to various economic settings, including health, consumption choice, labor supply, and insurance.
Finance: It helps explain investor behavior, such as the tendency to avoid losses more than seek gains.
Policy: Understanding Prospect Theory can inform policy decisions, as it highlights the importance of framing and reference points in shaping public opinion and behavior.
Prospect Theory and
Human Choice Biases & Deficiencies
Probabilities Confuse People
Probabilities Confuse People (I)
Certainty Effect
* People underweight medium and high probability events
* People overweight low probability events
* Emerges when it is difficult to distinguish between different rewards
* Causes firms & people to overinvest in the probability of small
events
* People hate losses, so will overinvest to avoid them
* Insurance thrives on this
Probabilities Confuse People (II)
S12 F11
Probabilities Confuse People (III)
Prospect Theory and
Human Choice Biases & Deficiencies
‘Isolation Effect’
‘Isolation Effect’
* People concentrate on the most ‘recent’ choice
* Almost never assess a new situation fully (likelihood of change)
Examples:
* See Climate Change
* New technologies like AI
* Startup Innovations…
Prospect Theory and
Human Choice Biases & Deficiencies
Ambiguity Aversion
Ambiguity Aversion
* When probabilities are unclear or ambiguous,
people tend to avoid decisions involving uncertainty.
* Even if avoiding ambiguity leads to worse outcomes.
Examples:
* You could combat climate change, but do not know if you succeed?
You do nothing…
* VW does not know if electric cars will give the same profits?
Advocate old combustion technology and rather not change
* A startup offers you great savings, better outcome, etc. – but not sure it works
Prospect Theory and
Human Choice Biases & Deficiencies
Sunk Cost Fallacy
Sunk Cost Fallacy
* People invested in something (whether time, effort, or money)
* They may irrationally weight the decision based on their past
investment rather than the actual probabilities of future outcomes.
Examples:
* You build all these roads, but cars have to go to save the climate?
Better keep cars and roads even if it will not work…
* You invested in digital solutions, then AI changes everything?
Better stick to old concepts then jump on the new curve…
Prospect Theory and
Human Choice Biases & Deficiencies
Myopic Risk Aversion
Myopic Risk Aversion
* People focus on short-term risks and outcomes
rather than considering long-term probabilities.
* This leads to an overreaction to short-term losses or gains.
Examples:
* Short-term, change to electric cars entails huge risks for VW,
but long-term the only chance of succeeding?
* Digitization & AI are cost-intense and require lots of risky changes,
but long-term the only chance of succeeding?
Prospect Theory and
Human Choice Biases & Deficiencies
Framing Effect
Framing Effect
* Way a decision or probability is framed heavily influences how it is
perceived.
* People may respond differently to identical probabilities depending
on whether they are framed as gains or losses.
Examples for same probabilities, different framings:
* Giving up cars makes you immobile and restricts your freedom
giving up your car frees up money, time, and is less hassle
* Solar panels are costly and cumbersome to install
Imagine never paying for electricity again
Prospect Theory and
Human Choice Biases & Deficiencies
Overconfidence Bias
Overconfidence Bias
* People tend to be overly confident in judgments and predictions.
* Often leads to misjudge probabilities.
Examples:
* VW has been successful in combustion engine cars,
➡️ assumes it will win in any car engine technology (Tesla).
* Amazon thinks it rules eCommerce
➡️ Does not see TEMU and SHEIN coming…
Prospect Theory and
Human Choice Biases & Deficiencies
Availability Heuristic
Availability Heuristic
* People judge probabilities based on how easily they can recall
examples of similar events (or not).
* This leads to biased probability assessments when recent or
emotionally salient events come to mind more easily.
Examples:
* Rhine has no water first time in centuries – never happened before
people ignore that is the new normal.
* VW always launched new models successfully
will be similarly successful with new electric models
(Consumer) Decision Making
Decisions are a Psychological Processes
Models of the Response Process
S21 F11
Stages in the Consumer Decision-Making PROCESS
Problem recognition ➡️ Information search ➡️ Alternative evaluation ➡️ Purchase decision ➡️ Postpurchase evaluation
Relevant Internal Psychological Processes
Motivation ➡️ Preceotion ➡️ Attitude formation ➡️ Integration ➡️ Learning
Consumer Motivations: Why do we do the things we do?
S 22 F11
How do we communicate our Needs?
S23
Models of the Response Process
S24
Methods of Measuring Feedback in the response hierarchy –
linking Observations to underlying Processes
Hierarchies of Intermediate Effects of Advertising (IEA):
depending on Product & Context (1
Hierarchies of IEA:
depending on Product & Context (2)
Hierarchies of IEA:
depending on Product & Context (3)
Hierarchies of IEA:
depending on Product & Context (3)
- Informative (thinker) – Model: learn-feel-do (rational)
Possible implications:
* Test: Recall, diagnostics
* Media: Long copy format, reflective vehicles
* Creative: Specific information, demonstration - Affective (feel-er) – Model: feel-learn-do (emotional)
Possible implications:
* Test: Attitude change, emotional arousal
* Media: Large space, image specials
* Creative: Executional impac - Habit (do-er) – Model: do-learn-feel (responsive?)
Possible implications:
* Test: Sales
* Media: Small ads, 10-sec I.D.s, radio, POS
* Creative: Reminder - Self-satisfaction (reactor) – Model: do-feel-learn (social?)
Possible implications:
* Test: Sales
* Media: Billboards, newspapers, POS
* Creative: Attention
