Final Flashcards
(100 cards)
decision making
- conscious selection among a number of options, often with uncertain outcomes
- not everything is controlled by a conscious decision –> some choices = habit
- there is a diff between deciding and doing
actually carrying out actions are determined by
- motivation
- context
normative decision
the objectively right decision
rational decision
one that follows certain basic principles of consistency and coherence
utility
how much value something has for you
expected value
amount (of money usually) you expect to gain/lose as a result of a decision
Expected utility theory
to compare 2 options
1) consider the possible outcomes associated with each option
2) estimate your utility (value) of each outcome
3) estimate the probability of each outcome
4) Multiply probability by utility for each outcome + add up all the outcomes
5) the total is that options expected utility
Expected Utility Theory Example
Two sandwiches. Compare outcomes for each one:
P(crab salad is good) * Utility of good crab salad + P(crab salad is bad) * Utility of bad crab salad
P(liverwurst is good) * Utility of good liverwurst + P(liverwurst is bad) * Utility of bad liverwurst
Choose sandwich with highest overall utility*.
Roulette Example
38 numbers: 1 - 36 (black & white) plus 0, 00.
Bet $1 on black
Expected Value is calculated as Prob(outcome) * value of that outcome
Winning: 18/38 * $1 = $.4737
Losing: 20/38 * $-1 = -$.5263 Expected value (sum) = $-.0526
So, why do people play, if they expect to lose 5% of their stake on each bet?
Test of Expected Utility Theory (The Allais Paradox)
Which lottery would you prefer? {expected utilities}
A. Probability .40 to win $100 [.4 * U100]
B. Probability .50 to win $70 [.5 *U70]
–> If people choose A over B, then .4 * U100 > .5 * U70
C. Probability .80 to win $100 [.8 * U100]
D. Probability 1.0 to win $70 [.8 * U100]
–> If people choose D over C, then .8 * U100 < 1 * U70
the fact that people prefer A to B and D to C is like saying that A > B but 2A < 2B. Inconsistent/irrational
Attraction Effect: Choosing a Graduate School
A. Harvard
—–>Excellent reputation; poor financial support
B. Indiana
—–>OK reputation; excellent financial support
C. Dartmouth
—–>Good reputation; bad financial support
OR
A. Harvard [same as above]
—–>Excellent reputation; poor financial support
B. Indiana [same as above]
—–>OK reputation; excellent financial support
D. Iowa
—–>Bad reputation; good financial support
- this also seems irrational
- the presence of an option you’re not going to choose should have no effect on which of the other options seems better
Explanation for Attraction Effect
People want to be able to justify their decisions
-Hsee (1999)
Hsee (1999): Record
-Asked subjects whether they would prefer to receive a Beatles CD or Barbra Streisand CD for being in his experiment (Beatles)
-Other subjects were told that they could do one
experiment for 90 points or another for 50 points the Beatles CD cost 50 points, and Streisand 90 (Streisand CD)
-even though they preferred the Beatles.
Hey, it’s worth 40 more points!
Shafir (1993): 2 Vacation Reservations
Option A (bland) Option B (mixed)
Half subjects asked to option to keep; half asked which to cancel
-Keep question Option B (mixed) is kept (67%)
-Cancel question
Option B is canceled 48% (i.e., is kept 52%)
i.e., Option B drops by 15% from “keep” to “cancel”
Shafir Summary: Are we irrational?
- Choices aren’t consistent in the Allais Paradox
- People change which option they choose depending on third option they aren’t going to choose
- People change their choices depending on whether they decide to keep or get rid of 1 of 2 options
- This sort of inconsistency does not meet standards of rationality, according to many.
- Framing effects
Framing effects
-How the choices are described or the context they’re put into a affects which one is preferred.
-Inconsistent with expected utility theory (and most rational theories), because it’s the actual choices that should matter—not how they’re
described.
-Classic examples often compare gains and losses
-People really hate losses
Tversky & Kahneman (1981) : Framing Effect Example
-unusual disease is expected to kill 600 people this year.
-2 alternative programs have been proposed to combat the disease.
A. 200 people will be saved.
B. 1/3 probability that 600 people will be saved, and 2/3 that no people will be saved.
C. 400 people will die.
D. 1/3 probability that no people will die, and 2/3 that 600 people will die
A: 72% B: 28%
C: 22% D: 78%
General Pattern of Risky Choices
- People like certainty when it comes to gains
- take a small sure gain over a gamble for a larger amount.
- prefer risk when it comes to losses
- take a gamble on a larger loss over a sure smaller loss.
- isn’t necessarily irrational
- unless it leads to different decisions, as in the disease problem
McNeil, Pauker, Sox, & Tversky (1982): dying framing (actual stats of the time)
100 people having surgery for lung cancer
– 10 die during or shortly thereafter
– 32 will die by one year
– 66 will die by five years
100 people having chemotherapy – none die during treatment – 23 die by one year – 78 die by five years • Note that surgery is worse immediately but better in the long-term
–58% chose surgery in dying frame and
McNeil, Pauker, Sox, & Tversky (1982): survival framing (actual stats of the time)
Of 100 people having surgery
– 90 live through treatment
– 68 survive one year
– 34 survive five years
Of 100 people having chemotherapy – all survive treatment – 77 survive one year – 22 survive five years • All subjects (patients, doctors, students) chose surgery more often in this (survival) framing than in the dying framing – 75% in survival frame
Tversky & Kahneman (1981): Loss Aversion
Decision 1:
A. a sure gain of $240
B. 25% chance of gaining of $1,000
75% chance of gaining nothing
Decision 2:
C. a sure loss of $750
D. 75% chance of losing $1,000
25% chance of losing nothing
A: 84% B: 16%
C: 13% D: 87%
The Endowment Effect (economist Richard Thaler)
-Once you have something, you value it a lot more than you would if you didn’t have it
-Owners of something think it is worth more than
potential buyers of something think it is
Status Quo Bias: Reasons
1) Current situation is considered “normal” and so is not perceived as loss or gain, even if it’s terrible
Any change will involve losses + gains
Add loss aversion and the status quo often seems better than any change
2) Status quo may have official sanction (employer, government, other institutions). car insurance example in text
“The current situation must be better, or else they wouldn’t make it standard.”
Tversky & Kahneman, 1981: Mental Accounting
-people group transactions into categories
jacket: $125
calculator: $10
-Would you walk 15 minutes to save $5 on this purchase?
-jacket 29%
-calculator 68%
-$5 seems worth different amounts, depending
on context
You’re going to the theater and discover that you’ve lost your $50 ticket.
Will you buy another to see the play?
vs.
You’re going to the theater and discover that a $50 bill fell out of your wallet.
Will you still buy a ticket (cost = $50) to see the play?
46% yes in first case vs. 88% in second*