| Chapter 13 Nonexpected utility theories: based on rationality principles but also describe behaviors Prospect theory: based on same principles as expected utility theory: an overall value is determined by decision weights (probabilities) and consequence values. Editing alternatives: constructing cognitive representation of actions, probabilities, and outcomes Setting a reference point: status quo, social norm, expectation, level of aspiration In expected utility theory, utility was defined in terms of net wealth In prospect theory, value is defined in terms of gains or losses based on a point of reference Combining or segregating outcomes to maximize satisfaction Mental accounting: prefer several small wins but only one big loss Evaluation: assess value of prospect and choose accordingly Valuation: apply value function to each consequence For gains: Value = X raised to the .88 power For losses: Value = -2.25 times X raised to the .88 power These formulas reflect loss aversion and the fact that losses are felt more strongly than gains Endowment effect: sellers value possessions more than buyers Decision weighting Tend to overweight small probabilities: very sensitive to the difference between impossibility and possibility Well calibrated at .2 Tend to underweight intermediate and high probabilities: leads to superadditivity Certainty effect: important for people to be certain; prefer to eliminate rather than reduce; inflate importance of improbable events because we overweight small probabilities Integration: add up weighted values across outcomes Prospect theory is not perfect but it can predict framing effects |
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