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Flashcards in Decision making theories Deck (17)
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What are choices based on?

Beliefs - about how the world is and what the outcomes of actions might be

Desires - what the person making the choices likes or wants to happen

both subjective


What does utility theory believe?

That you should make choices that have the highest utility (subjective value) for you

when choosing what to do, outcome has multiple attributes, some are more important than others


What does multi-attribute utility theory believe?

You should weight the attributes according to their importance and combine the values of each object on each attribute to get an overall utility


Choices among actions

Eg. invest in government bonds vs stocks and shares vs savings account
go to a club, stay home

there are possible outcomes following the same action (a night out may be good or bad)

to calculate the average utility of an action, each outcome must be weighted by its probability


The origins of utility theory

Foundations lie in analysis about gambling - people are regarded as rational, interested decisions makers, making choices that maximise expected utility


What does risk aversion mean?

We avoid risks


Risk aversion and money

A sure offer of 50 pounds is preferred to an equal chance of having 0 or 100 pounds


Which is important? absolute value or change in value?

Jack and Jill both have 5 million
Yesterday jack had 1, Jill had 9
which is happier?
utility theory lacks the concept of a reference point, thinks people will be the same but Jill has lost lots


What is the prospect theory?

Outcomes should be defined in terms of gains and losses not in terms of absolute utility levels


What is utility theory an example of?

A normative theory, tries to prescribe what should happen


What does loss aversive mean?

The prospect of losing a certain amount is more aversive (negative) than gaining the same amount - people worry more about a loss of the same size than a gain of the same size


What are consequences of loss aversion?

It can make bargaining difficult - the losers fight harder because they don't want to lose money


What is the explanation of being loss aversive?

Evolution - severe loss leads to inability to pass on genes


Golf putts

Golfers were 3.6% bette on putts t avoid missing a par vs putts to get a birdie (gain)

tiger woods would've earned 1 million more if he had putted 3.6% better when going for birdies


What happens if you continue making risky decisions?

Overtime, will lose out on opportunities because don't want to lose anything
need to avoid excessive caution


Seeking and avoiding risks

Most people are risk aversive for gains and risk seeking for losses


How does prospect theory explain loss aversion and risk seeking and avoidance?

Value function

high probability - certainty
gains - risk averse, don't want to disappoint
losses - risk seeking, hope to avoid loss

low probability - possibility
gains - risk seeking, hope of large gain (lottery)
losses - risk averse, fear of large loss