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Thinking and Deciding 11: Descriptive theory of choice under uncertainty

09/21/2013

Experienced, predicted, and decision utility

Three types of utility exist. Experienced utility is the one that matters. Predicted utility is what we predict the utility of an event will be. Decision utility is inferred from what we actually choose. These different utilities sometimes conflict because people don’t know exactly how to measure true utility.

Prospect theory

Prospect theory is a descriptive theory of choice formulated by Kahneman and Tversky. Similar to expected utility theory, we weigh more likely outcomes more heavily. Instead of certain outcomes having objective value though, they are valued from certain reference points. Losing x has more negative utility than gaining x has a positive utility.

People also heavily value certainty as compared to near certainty. The jump from .99 to 1 leads to very high decision utility. Also, a jump from 0 to .01 also leads to a disproportionate jump in utility.

Framing effects mark a significant source of bias in decision making under prospect theory. If we frame things in terms of lives saved, we will value it differently than if we frame in terms of lives lost, even when the situations are identical.

Rank-dependent utility theories

Prospect theory is not able to account for all the heuristics humans seem to use, especially when more than 2 things are considered. We can approximate different risky decisions by taking into account how people think about security, opportunity, and aspiration.

People tend to rank things from best to worst, and will use the idea of x or better. As in choosing one option will provide 5 units of utility for sure, and then a small chance of 10 utility.

Emotional effects of outcomes

Regret and rejoicing further complicate the a descriptive account of choice. For example, winning $5 can have totally different values if one had a 95% chance of winning 1 million and a 5% chance of winning $5 vs. a 95% chance of winning 0, and a 5% chance of winning $5. In both circumstances, a person gains $5, but in one, a person will probably feel reaaaaally crappy.

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