L11

Question 1

What type of decision models allow irrationality, and what type restricts human behaviour to be rational?

Answer 1

Normative restrict it to rationality, descriptive allow irrationality

Question 2

What does rank dependent utility allow for? (2)

Answer 2

Probability sensitivity and outcome sensitivity

Question 3

What is probability sensitivity?

Answer 3

It means that we generally over-weigh are are tf more sensitive to the probabilities at each end of the probability spectrum (close to 1 or 0) (eg. jump from .->0.1 feels more than jump from 0.5->0.6) (see diagram)

Question 4

Draw RDU diagram? What is meant by distorted probability, and what does the curve represent?

Answer 4

(see notes for diagram)
Distorted prob.=the probability weight
S-shaped curve=probability weighting function

Question 5

How are small and large probabilities weighted? Give examples?

Answer 5

Small prob. are OVERweighted (explains people buying lottery tickets)
Large prob. are UNDERweighted (explains not participating in extreme sports even though you’ll almost certainly be fine)

Question 6

What is outcome sensitivity?

Answer 6

Another psychological aspect captured by RDU, which is our attention to salient (more noticeable) objects (see example)

Question 7

Total weight for RDU is called?

Answer 7

Decision weight

Question 8

Difference between EU and RDU?

Answer 8

In RDU, probability is replaced by decision weight

Question 9

What is prospect theory wrt RDU?

Answer 9

Idea of using a reference point to help capture loss aversion (see notes)