Chapter 7

# Chapter 7 - Rational choice theory Wednesday, October 07,...

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Expected utility = probability of outcome * value of outcome EU = .8*\$10 = \$8.00 ± Choice 1:80% chance to get \$10 EU = .05 * \$100 = \$5.0 ± Choice 2: 5% chance to get \$100 People make decisions by comparing the expected utility of their options iPods are really worth what people are paying for them ± Bubbles (over estimates of value), if not impossible, are highly unlikely! ± If people make rational choices, then free markets provide accurate estimates of value: An enormously influential idea: Rational choices rely on accurate estimates probabilities and values of events Are influenced by a variety of purposes Humans are not particularly good at doing either: Calculating probabilities is complex Much better at dealing with frequencies: how often something occurs rather than its likelihood ± And, Humans do not appear to have evolved using much probability information Satisficing : reaching a judgment that is 'good enough' Avoid complex calculations by using rules of thumb that often, but not always , provide a good answer ± Errors are biased , not random Use of heuristics leads people astray in a predictable ways ± So, when it comes to probabilities, we tend to rely on mental shortcuts/ Biased probability estimates

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## This note was uploaded on 02/13/2012 for the course RANDOM 100 taught by Professor Idk during the Fall '08 term at Virginia Tech.

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Chapter 7 - Rational choice theory Wednesday, October 07,...

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