# Prospect Theory

Avoiding Uncertainty: a common response

Reward results and punish failure

Cut research & training during budget crises

\$140,000 to prevent a highway death;
\$5,000,000 to prevent a death from radiation
A Normative Background to Risk:

probability, expected value, risk considerations
The Framing of Information

 save one plant, 2000 jobs,  or 50% chance of saving 3 plants, 6000 jobs 50% chance of saving none lose 2 plants, 4000 jobs,  or 50% chance of losing none 50% chance of loing all 3 plantsm 6000 jobs
p.49 "rational decision makers should be immune to the framing of choices."
The Framing of Risky Decision

 Gains versus Losses ("The Framing of Choices") Choose 1 row from left column, 1 row from right column (A1) A sure gain of \$240 (B1) A sure loss of \$750 (A2) 25% chance of \$1000 gain, 75% gain nothing (B2) 75% chance to lose \$1000,  25% lose nothing Choose 1 row: (C1) 25% chance of a \$240 gain, 75% chance of \$760 loss (C2) 25% chance of a \$250 gain, 75% chance of \$750 loss
Anchors Matter

Lose the tickets on the way to the theater: do you buy new ones at the door?
Lose the cash you were going to use to buy tickets at the door; do you charge the tickets?
Certainty Effect

 (D1) Winning \$50 with probability .5  (D2) Winning \$30 with probability .7 (E1) Winning \$50 with probability .8  (E2)  Winning \$30 with probability 1.0
Pseudocertainty:

 problem 4: choose between \$30 for sure or an 80% chance at \$45, 20% of zero problem 5: 75% chance of being out of the gam in round 1;  if you win round 1, choose between \$30 for sure or an 80% chance at \$45, 20% of zero problem 6: choose between 25% chance at \$30 & 75% of zero,  or a 20% chance of \$45 80% of zero
Problems 5 & 6 are mathematically indentical
"Insurance Premiums:" Sound Better Than "Guaranteed Loss"
Transactional Utility ("What's It Worth to You?")

friend brings you a bottle of beer from fancy resort or rundown grocery
How Much is Your Time Worth?

20 minutes to get something for \$25 instead of 50
20 minutes ot get something for \$475 instead of \$500
The Value We Place on What We Own

Historical cost, replacement cost, and real utility