Prospective Theory: Subjective Utility

Question 1

Satisficing

Answer 1

• Developed by Herbert Simon (1957) as a way of accounting for the decisions that do not conform to EUT
• Essentially the concepts of goals is distilled into a threshold.
• People consider the options before them and when one reaches above the goal in an acceptable way, that is the option that is chosen.
• A common e.g. is the purchasing of electrical goods. People typically compare a limited number [depending on convenience] of e.gs. and choose the one that is “satisfactory” accepting the fact that there could be a ‘better’ one elsewhere.
• NB procrastination is the outcome of never ending search.

Question 2

• Prospect Theory
  
  • Main concepts

Answer 2

• This theory was developed by Kahneman & Tversky.
• Theory in response to the shortcomings of the normative approach of EUT and redefines several key concepts in order to better represent how people make decisions.
• First and foremost the EUT term “utility” is replaced by “value”. Value is defined in terms of gains and losses from some reference point.
• A vast amount of experimental work has been conducted in the prospect theory paradigm.

Question 3

Prospect theory

Answer 3

• Participants differ in their decision making depending on whether they are considering a gain or loss.
  
  • Most choose a certain gain vs 50% chance of winning 1k
    
    • Gains are risk-averse
  • Most choose a 50%-50% chance of losing 1k over 100% of losing $500
    
    • Losses are risk-seekers
  • Framing choices example of disease outbreak
• The asymmetrical “S” curve
  
  • Gains and losses are treated differentially by most participants in the experiments conducted in this research.
  • The effect of framing the problem as gains or losses is to produce very different results. People seem to be risk averse when it comes to gains and risk seeking when it comes to losses.
  • Big finding of Prospect Theory. Represented by the “s” shaped curve.
    
    • E.g. voting trends - the incumbent is viewed as a loss and so the challenger must be a very significant value option, and
    • Negotiations where surrendering claims may be experienced as a loss.
  • Also loss averse with trial of loaned goods (also “endowment effect”)
  • The concept of decision framing is one of the main contributions of Prospect Theory.
  • Framing explains the data that is generated by such experiments as the Allais paradox and other decision results where the context is said to influence the decisions taken.
  • Framing curve
    
    • Concave for gains with a steep reduction in marginality value
    • Convex for losses with a very steep drop in the sensed marginal value
• Probability estimates
  
  • The estimation of the likelihood of an event is critical to the weight its occurrence will be given in making a decision [90% vs 20% chance of rain will influence taking a raincoat].
  • Prospect theory as a result of manifold experiments asserts that humans have a non-linear probability weighting approach to events.
  • There are four regions of interest in the graph of the decision weights function
    
    • 1. Close to zero point people are very sensitised to the difference between no chance and any chance
    • 2. There is a crossover point at about p=.2 where in the experiments people are well calibrated in terms of objective chance.
    • 3. In the middle of the graph people are insensitive to changes in objective probability [dashed line]
    • 4. Close to p=1.0 people show still an underestimation of the actual chances [solid line].

Question 4

Representativeness

Answer 4

• People judge the probability of an event or thing based on the degree to which “A” resembles “B”
• A and B can be things, people, events or any other category about which a decision must be made.
• Linda problem – bank teller and feminist
  
  • In K&T’s sample the favour choice of B is illogical as it is not statistically possible for that two probabilities multiplied together cannot be more than the single probability.
  • People are not good reasoners as they are distracted by story detail which is more in line with pre-existing views and opinions.
• Hospital male birth e.g.
• Base Rate neglect. People make assertions about the likelihood of an occurrence based on their impressions not on actual numbers in the population
• The real question is not the findings but the interpretation
• The description used in K&T’s research (and others) all make sense and are very compelling. Raises the question of their effectiveness rather than their accuracy based on normative statistical or other standards.

Question 5

Availability

Answer 5

• Make judgments based on the ease with which instances of an occurrence are brought to mind.
• It is asserted that the Availability heuristic is at the bottom of such misconceptions as probability of death from aircraft accident or by a shark.
• Researchers have found that imagination plays a role in an event being more easily accessible and therefore more impactful on judgement processes -> human ability to play with concepts and generate scenarios.
• Vividness also has an impact again with distortion the most likely outcome.
• Gigerenzer (2004) asserts that more people have been killed as a result of car fatalities in the US than aircraft passengers killed in the 9/11 hijackings. This is a result of the diverting of air travel to car travel. This is an example of the vividness and emotional associations of air travel after 9/11.

Question 6

Anchoring and adjustment

Answer 6

• Starting values seem to inhibit subsequent judgements even when ‘evidence’ strongly suggests such adjustment should be made.
  
  • E.g. 1x2x3x4 vs. 4x3x2x1
• Interesting e.g. of this heuristic is the instructions to jury to consider verdicts in a predefined order. Start with the harsher one will anchor the final verdict at a more punitive level than starting at the lenient end.
  
  • Mock jurors award substantially different amounts depending on starting point
  • Research has found that where you start has an enormous influence on what is awarded.
  • Start around $15 million and you stay there, start at $50 million and that is where is you sit. NB for the same scenarios, injuries, characters and negligence.

Question 7

Affect heuristic

Answer 7

• Many researchers have recognised over the last 20 years the importance of the role emotion/affect plays in information processing and decision making. Kahneman himself has indicated that the affect heuristic is a very important.
• Schwarz (2002, p534) assert that “happy moods foster reliance on top down heuristic processing…whereas sad moods foster…detail-oriented bottom up processing.”
• The role of affect in human decision making is beginning to be seen as primary over analysis as Zajonc asserted back in 1980.
• Affect valence information seems to be weighted more heavily in many decision processes resulting in a default position of what feels appropriate is much more difficult to move away from than other information.
• Affect as a guide to information utilisation is more prominent when task demands increase (e.g. time) and cognitive resources diminish

Question 8

Reaction to the H&B position

Answer 8

• The normative claim of EUT was rejected by K&T but soon others took up the normative position based on H&B findings. These authors asserted that human beings were flawed thinkers and so labelled as irrational.
• Gigerenzer et al was among a widespread group who question the assertion that human beings are illogical. These authors cite the fact that as a species humans have made remarkable progress.
• Commonly these authors take an evolutionary perspective and assert that the development of human cognitive features, processes and structures are the result of an adaptive process not randomness.
• Some of the outlandish ‘human irrationality’ assertions based on H&B research findings are NOT consistent with Kahneman & Tversky’s stated position. They acknowledge that Heurstics can in many circumstances be useful and effective but not in all.
• The great achievement of the H&B research program is to have brought into very clear focus critical processes in human thinking, reasoning and judgement. Kahneman in his 2002 Nobel reception lecture (Kahneman, 2003) acknowledges that the most likely explanatory model is a Dual Process system of human thinking which we examine next.