Prospect theory Flashcards
What is the primary focus of behavioral economics?
The interaction between psychology and economic decision-making
Behavioral economics examines how psychological factors influence economic behavior.
Who developed the behavioral economic theory?
Psychologists
Behavioral economics is rooted in insights from psychology, challenging traditional economic assumptions.
Fill in the blank: Behavioral economics is a theory that combines _______ and economic decision-making.
[psychology]
True or False: Behavioral economics assumes that individuals always make rational decisions.
False
Behavioral economics suggests that individuals often act irrationally due to cognitive biases.
What does behavioral economics explore about human behavior?
How psychological factors affect economic decisions
This includes understanding biases, heuristics, and social influences on decision-making.
Fill in the blank: Behavioral economics challenges the traditional view of _______ in economic theory.
[rationality]
What is Prospect Theory?
A behavioral economic theory developed by Daniel Kahneman and Amos Tversky in 1979 that describes how people make decisions involving risk and uncertainty
What does Reference Dependence refer to in Prospect Theory?
People evaluate outcomes relative to a reference point rather than in absolute terms
What is Loss Aversion?
Losses feel more painful than equivalent gains feel pleasurable, with losses being about twice as psychologically powerful as gains
What is an example of Loss Aversion?
Losing $100 feels worse than the pleasure of gaining $100
What does Diminishing Sensitivity mean?
The subjective difference between gains or losses decreases as the amount increases
Fill in the blank: The difference between gaining $100 and $200 feels more significant than the difference between gaining $1,100 and _______.
1,200
What is Probability Weighting?
People tend to overestimate small probabilities and underestimate large probabilities, leading to inconsistent risk behavior
What is the shape of the value function for gains in Prospect Theory?
Concave for gains
What is the shape of the value function for losses in Prospect Theory?
Convex for losses
How does the value function illustrate loss aversion?
It is steeper for losses than for gains
What are Framing Effects?
How choices presented as gains or losses can influence decisions
What is the Endowment Effect?
People value things they own more highly than identical things they don’t own
How do risk preferences change according to Prospect Theory?
Individuals may behave differently depending on whether they perceive a situation as a potential gain or loss
What are some applications of Prospect Theory?
- Economics: Understanding market behaviors and consumer choices
- Public Policy: Designing better communication strategies
- Negotiation: Recognising how framing offers as losses or gains can impact outcomes
True or False: Prospect Theory supports the traditional Expected Utility Theory.
False
What does Prospect Theory reveal about human decision-making?
It shows that human decision-making is often irrational and influenced by psychological biases
