Week 8

Question 1

Steps of rational decision making (6 steps)

Answer 1

1. Define the problem
2. Identify the criteria
3. Weight the criteria
4. Generate alternatives
5. Rate each alternative on each criterion
6. Compute the optimal decision
   –> a) multiply the ratings of each alternative by the weight of each criterion
   b) add up the weighted ratings across all of the criteria for each alternative
   c) chose the solution with the highest sum of the weighted ratings

Question 2

System 1 vs System 2

Answer 2

System 1: intuitive system
System 2: reasoning that is slower, conscious, effortful, explicit and logical

Question 3

What are the limits of bounded rationality?

Answer 3

1. Individuals often lack important information
2. Time and cost constraint limit the quantity and quality of available information
3. Decision makers retain only a small amount of information
4. Intelligence limitations and perceptual errors

Question 4

What are NUDGES?

Answer 4

Any aspect of the choice architecture that alters people’s behaviour in a predictable way without forbidding any options or providing economic incentives

Question 5

What are the 3 points in Prospect Theory?

Answer 5

1. Reference point
2. Loss aversion
3. Diminishing sensitivity

Question 6

REFERENCE POINT

Answer 6

Value isn’t inherent in an offering and can’t be assessed in absolute terms.
Any evaluative judgement requires a reference point, with respect to which the offering is compared, to assess its advantages.
Anything can be portrayed either as a loss or as a gain.
Framing is fundamental because people behave differently with respect to losses compared to gains

Question 7

LOSS AVERSION (also STATUS QUO BIAS)

Answer 7

The slope of the value function is steeper for losses than for gains - -> people have a stronger drive to avoid losses than to seek gains
Decision makers tend to be risk averse when choosing btw gains and risk seeking when choosing btw losses
Loss aversion leads to STATUS QUO BIAS (tendency to stick to current state)

Question 8

DIMINISHING SENSITIVITY (produce increment in perceived value)

Answer 8

Reflected in the shape of the value function (concave in the domain of gains and convex in the domain of losses)
To produce a meaningful increment in perceived value, bigger and bigger actual outcomes are necessary.
DS implies that improving an offering’s performance on a certain attribute becomes progressively less and less valuable.

Question 9

JUDGEMENT HEURISTICS

Answer 9

People rely on a number of simplifying strategies when making decisions.
They serve as a mechanism for coping with the complex environment surrounding our decisions

Question 10

AVAILABILITY HEURISTICS

Answer 10

People asses the frequency, probability or likely causes of an event by the degree to which instances of that event are readily “available” in memory

Question 11

REPRESENTATIVENESS HEURISTICS

Answer 11

When making a judgement about something, people tend to look for traits an individual may have that corresponds with previously formed stereotypes

Question 12

CONFIRMATION HEURISTICS

Answer 12

We intuitively use selective data when testing hypotheses, such as instances in which the variable of interest are present

Question 13

AFFECT HEURISTICS

Answer 13

Most of our judgements are evoked by an affective or emotional evaluation that occurs even before any higher-level reasoning takes place

Question 14

BIASES

Answer 14

Usually result when an individual inappropriately applies a heuristic when making a decision.
Usually have a negative correlation