Decision Making 09

# Decision Making 09 - Reasoning Decision Making Though...

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Though often studied using abstract materials, research on reasoning & decision making can shed light on real-world topics: --economic decisions (e.g., stock market analysis --jury decision-making --risk assessment --actuarial science (RE: Insurance) --medical diagnosis --consumer behavior --attributions of cause --acceptance or rejection of the null hypothesis in experiments Recommended books : Levitt, S.D., & Dubner, S.J. (2005). Freakonomics , New York: William Morrow. Sedlmeier, P. (1999). Improving statistical reasoning , Mahwah, NJ: Lawrence Erlbaum. Paulos, J. (2001) Innumeracy: consequences Rowntree, D. (1984). Probability without tears . New York: Barnes & Nobles.

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I. Theories of Decision Making A. Economic Theories 1. Assumes people are [statistically] rational decision makers. 2. Expected-Value Theory --decision is like a gamble; use probabilities to ascertain value or utility of a decision (relative to its costs) What SHOULD you pay for a single lottery ticket under the following scenario? 10 tickets in a lottery; 1 pays \$10, and 3 pay \$5, the rest pay nothing: EV = [Pr(Win) x Value(Win)] + [Pr(Loss) x Value(Loss)] = (.1 x \$10) + (.3 x \$5) + (.6 x 0) = \$2.50 --Is a Normative model —what people SHOULD do under optimum circumstances. Assumes that a rational person can measure utility under all circumstances & make decisions accordingly (Bernstein). 3. Expected UTILITY: replaces the Value of a win/loss with its Utility (and thus accounts for subjective worth of a win/loss to a person): EU = [Pr(Win) x Utility(Win)] + [Pr(Loss) x Utility(Loss)] = --harder to calculate, but does explain less-than-rationale decisions 4. Subjective Expected Utility : Replaces probabilities with subjective probabilities (either when exact probabilities are unknown or when people’s perceived probabilities are most influential in making decisions). SEU = [SPr(Win) x Utility(Win)] + [SPr(Loss) x Utility(Loss)] --more descriptive of human decision making
B. Prospect Theory: the culmination of SEU predictions ( Kahnemann & Tversky, 1979; Kahnemann, 2003) 1. Subjective Value : Value of a choice is calculated based on the Subjective Utility/probability RELATIVE to some reference point 2. Reference Point : Value is defined in terms of gains & losses (relative to some vantage point) Explains Framing Effects 3. Asymmetry of Gains/Losses --Displeasure associated with loss is much greater than the pleasure associated with a commensurate gain Loss Aversion 4. Immediacy of Risks/Gains : Huge risks in the future are ignored (e.g., don’t change diet & lifestyle early enough to prevent heart attack or stroke) Immediate small benefits often preferred to longer-term, large gains (e.g., going to concert rather than saving money for new car or house down the road). II.

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Decision Making 09 - Reasoning Decision Making Though...

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