L13 Intro to decision making

Question 1

What are the three different approaches to decision making?

Answer 1

Normative

Descriptive

Prescriptive

Question 2

What is normative decision making

Answer 2

What a rational person would do

Question 3

What is descriptive decision making

Answer 3

What people actually do

Question 4

What is prescriptive decision making

Answer 4

Given the gap between rational and descriptive - what should people do

Question 5

What is a judgement?

Answer 5

Estimates about the value or likelihood of particular events or outcomes (or quantities)

Question 6

What are the components of a judgement?

Answer 6

1. The unobservable state of the world (uncertainty)
2. Cues

Question 7

Describe what cues are

Answer 7

Observable features that may be more or less predictive of the unobservable state.

Question 8

In what ways do cues vary?

Answer 8

In predictive strength (different cues are better than others)

and utilization (people don’t pay attention to cues the way they should)

Question 9

What are the components of a decision?

Answer 9

Alternatives

States of the world

Outcomes

Utilities

Objectives

Question 10

How do states of the world and alternatives combine in decision making?

Answer 10

Different states of the world will influence the type of alternative you decide to choose.

(e.g. cancer will spread if not taken out = removal of cancer // if benign = no removal)

Question 11

What are the two types of decision situations?

Answer 11

Uncertainty (the state of the world are unknown and probabilities are unknown)

Conflict (like uncertainty and other people’s choices affect outcomes)

Question 12

Which two key components of a decision should be considered to understand the possible outcomes?

Answer 12

States of the world and alternatives

Question 13

In decision making, what does ‘alternatives’ mean?

Answer 13

The different decisions that can be made.

Question 14

In decision making, what does ‘states of the world’ mean?

Answer 14

Conditions that may/may not be present; relevant to the decision or not under your control (uncertainty)

Question 15

In decision making, what does ‘outcomes’ mean?

Answer 15

Possible alternate states of the world

Question 16

In decision making, what does ‘utilities’ mean?

Answer 16

The subjective value of an outcome

(e.g. some people think nausea is a worse outcome than others)

Question 17

In decision making, what does ‘objectives’ mean?

Answer 17

Things you wish to achieve when making the decision

• Can override other aspects of decision making*
  (e. g. cancer patient not getting treatment because they want to keep their money (maintain wealth))

Question 18

What type of theory is expected utility theory (EUT)

What does this mean?

Answer 18

Normative

How you should make decisions if you were a perfectly rational being

(theory is based off economics)

Question 19

What are the 6 principles of expected utility theory?

Answer 19

Dominance

Ordering of Alternatives

Cancellation

Continuity

Invariance

Transitivity

(D.O.C.C.I.T)

Question 20

In EUT, describe the principle of ‘ordering of alternatives’?

Answer 20

Prefer one alternative over the other, or be indifferent

Question 21

In EUT, describe the principle of ‘dominance’?

Answer 21

Always choose the dominant alternative (one which gives highest utility)

Question 22

In EUT, describe the principle of ‘cancellation’?

Answer 22

Same outcomes in different alternatives will cancel each other out

Question 23

In EUT, describe the principle of ‘transivity’?

Answer 23

Prefer A over B, and B over C, then will prefer A over C

Question 24

In EUT, describe the principle of ‘continuity’?

Answer 24

Prefer gamble between 10 bucks and nothing to a sure gain of 10 bucks, provided the chances of getting nothing are minuscule

Question 25

In EUT, describe the principle of **'invariance'**?

Answer 25

Should be unaffected by the way alternatives are presented

Question 26

What is the Allias Paradox?

Answer 26

Both A-C and B-D are the same, however, people prefer A in the first scenario and D in the second (preference reversal).

Question 27

What EUT principle does the Allias paradox violate?

Answer 27

The cancellation principle

Question 28

What does the Alliax paradox tell us about EUT?

Answer 28

It is an unreasonable model because it assumes people are fully rational in their decision making.

Question 29

What type of theory is **Prospect Theory** (Kahneman and Tversky)? What does this mean?

Answer 29

**Descriptive** It is a theory that accounts for the behaviour of real decision makers.

Question 30

What are the two innovations of **Prospect Theory**?

Answer 30

People make decisions based on **value** instead of utility **Losses** mean more than gains to people.

Question 31

In prospect theory, what are **'framing effects'**?

Answer 31

The way a question is framed influences the outcome of a decision. (e.g. people are more hesitant if a risk is framed in terms of a loss instead of a gain)

Question 32

What does Prospect Theory say about when people overweight or underweight probabilities?

Answer 32

People overweight **small probabilities** People underweight **large probabilities**

Question 33

What is the **Endowment Effect**?

Answer 33

Something is considered to be of **greater** value when the prospect of **losing** it looms large. (We value things we are losing more than things we are gaining)