Probability Weighting

BE

Prospect theory

retains utility theory as a logic of rational choice but abandoned the idea thta people are perfectly rational choosers including loss aversions, reference dependence, and probability weighting.

Probability weighting

Describes bias when confronted with percentages and chances

Probability is…

the likelihood that some defined event will occur (percentage & frequency).

When is probability meaningful:

If the events are well defined, exclusive and exhaustive.

Example of undefined event:

Weather

Rationality and probability weighting

A rational person will assign consistent and complete preferences when confronted with percentages and frequencies.

Availability effect

Construct scenarios in your mind: bring to mind a vivid scenario about an event. It will seem more real and thus more probable.

Ex. If a car crashes was recently been listed on the news, you are more likely to believe that car crashes are more probable than they really are.

Subjectivity of Probability Judgments

Low-probability events factor more into decisions than they should. People underweight probable events, and overweigh improbable events.

Tools for changing how to deal with probabilities

• use the availability heuristic to your advantage to improve the accuracy of our judgments for low and high probability events.