Chapter 7 - Rational choice theory Wednesday 10:12 AM...

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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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Chapter 7 - Rational choice theory Wednesday 10:12 AM...

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