Lecture 2 - Decision Making & Interaction

Question 1

Classical decision-making model

Answer 1

1. Defining the problem
2. Identifying decision criteria
3. Putting weights on criteria
4. Generating the decision alternatives/solutions
5. Rate each alternative on each criterion
6. Compute the optimal solution

Question 2

Manifestations of bounded rationality

Answer 2

1. Heuristics
   o Intuition, rule of thumbs, etc. are useful
2. Biases – Decision-making errors
   o Framing of alternatives
   i. Loss aversion: losses are felt more than gains of same amount
   ii. Escalation of commitment: investing additional resources in a losing project
   o Biases related to perceiving, judging alternatives
   i. Confirmation bias: high weight on evidence consistent with favored belief
   ii. Groupthink: conformity-seeking makes us disregard alternatives
   iii. Knowledge-bias: assume others know what we do
   o Action-oriented biases
   i. Excessive optimism: overestimate positive events, underestimate negative
   ii. Self-serving biases: overestimate own skill/contribution relative to others
   o Stability biases
   i. Status quo bias
   ii. Present bias: value immediate rewards highly, undervalue long-term gains
   iii. The endowment effect: we ascribe more value to things when we own them

Question 3

Key idea of decision achitacts

Answer 3

Shape decision environment so decisions benefit the firm

Question 4

2 Definitions of Efficiency

Answer 4

• Efficient
  o When the sum of consumer and producer surplus is maximized
• Pareto efficient
  o When there is no other allocation available which improves the well-being of one player without decreasing the well-being of others

Question 5

How non-cooperative game theory can be used to organize the managerial implications of organization theories

Answer 5

• Change the players
  o Increase/decrease number of players (vertical integration)
  o Get rid of bad suppliers
• Change the choice possibilities
  o Decrease/increase (no return)
  o Change job descriptions
• Change the payoffs
  o Change reward structure
  o Pay more than rivals (hurts more to lose job)
• Change the information structure
  o Increase monitoring
  o Management information system, financial control, activity-based costing, benchmarking
• Change the rules
  o Simultaneous vs. sequential
  o Repeated interactions