Week 12 Cognitive Decision Making

Decision Making

Despite the errors that occur when we make judgment, these

judgment form an important part of the database for the process of

decision making. Decision making includes a choice between

alternatives. With the increase in the number of alternatives

available the probability/chance of alternatives being wrong also

increases – leading to the increase of risk/uncertainty in choice

threshold approach of choice

According to the threshold approach of choice (Clemen,1991), if a

decision depends on the likelihood of another event happening,

then the attractiveness of the option should increase as the

probability of the other event increases. Once that probability

reaches a minimum level of certainty, the alternative would be

chosen.

Decisions which involve over-confidence in judgment attain

the minimum level of certainty too easily leading to choice of

wrong/un-rewarding choices

Expected Utility: A Normative Approach

Economists are interested in the factors involved in choice

and what type of model describes rational choice behavior.

One of the well-established theories of decision making is

expected utility theory

the theory states that when faced with some type of uncertain

choice, we make our decisions based on two factors

1) the expected utility of the outcomes

2) their respective probability

Utility refers to whatever end a person would like to achieve, be it

happiness, money or something else. Broome (1991) suggests –

utility refers to the amount of good that comes out of a decision.

Thus while making decisions we weigh the good that might come

out of each alternative against the cost of that alternative. We also

access the probability of each alternative occurring. Whatever

alternative provides the best combination of “good” and

“likelihood” will be the chosen one. Consider

flip a coin; if it turns up head, you get $40

Roll a dice, if it come up 4, you get $50.

Which option would you chose?

Violation of Expected Utility

One of the normative predictions made by expected utility theory is

that our choices should show invariance's; that is, a decision

maker’s choice should not depend on the way a choice is presented.

If I prefer choice A over choice B in situation 1, then I should prefer

choice A over choice B in situation 14 (as long as A and B are

identical in the two situations)

People often switch their preferences of one outcome over another,

based on how these outcomes are presented, demonstrating

irrationality. Consider the preference reversal shown (Lichtenstein &

Slovic, 1971). Their general procedure involved having subjects look

at two different gambles and decide – (1) which gamble they would

like to play & (2) how much the gamble was worth.

Multiattribute Utility Theory

(MAUT)

• What if the choices differ on many

dimensions?

• Example: Choosing a major

• Majors differ in many ways: your interest in

them, the job market after graduation, the

faculty, etc.

•How should one choose?

Steps IN MAUT

Steps in MAUT

1. Break the decision down into its important dimensions.

2. Determine the relative weight (importance) of each

dimension.

3. List all of the alternatives.

4. Rank the alternatives along each dimension.

5. Multiply each ranking by the appropriate weight.

6. Choose the alternative with the highest value.

Prospect Theory

One popular alternative to expected utility theory is

Kahneman & Tverskys (1979) prospect theory. Prospect theory is a

descriptive model of decision making that attempts to describe how

we make decisions and why our decisions violate the expected

utility model. The theory states

decisions are not valued based on the absolute value of the

end result, as proposed by expected utility; instead we value

decisions based on the amount of gain or loss from what we have

right now. It also adds that gains and losses are on different scales

of value.

The value we attach to gain increases

more slowly as a function of the size of

the gains than does the (negative) value

we place on the loses as a function of

the size of the loss. Basically we feel

losses more acutely then we feel gains;

the psychological pain associated with

losing $50 is greater than the

psychological pleasure of gaining $50.

prospect theory predicts that people will

be especially aversive to loss and will

show difference in preference

depending on how alternatives are

presented or framed

Framing

Framing – is the term used to describe the effects on our

decisions oh how a scenario is presented.

Prospect theory predicts our preferences will change

whenever our reference point changes. Decisions can be

influenced by how information is presented. If information is

presented in terms of a positive “gain frame”, we will be more

likely to avoid risk (risk averse) and pick a sure bet. However if

the same information is presented in a negative “loss frame”,

we will be more likely to take a risk (risk prone) to avoid loses.

Consider the results of a classic study by Tversky &

Kahneman (1981). Subjects were presented with this scenario

and two choices

Psychological Accounting

this principle states that people will make different decisions

depending on how the outcomes is felt or perceived. Consider

1) imagine you have decided to see a play for which admission is $10 a

ticket. As you enter the theater, you discover that you have lost a $10

bill. Would you still pay $10 for a ticket to the play? The principle of psychological accounting suggests that individuals categorize and evaluate monetary outcomes differently based on the context or perceived significance of the money involved.

Sunk Cost

the sunk cost effect is another interesting variation of the notion

of psychological accounting. This effect was demonstrated by

Arkes and Blumer (1985) In one experiment

subjects were to imagine that they had purchased tickets for two

different ski trips: one ticket (for trip to Wisconsin) cost $50,

while the other ticket (for trip to Michigan) cost $100. the

scenario made it clear that the trip to Wisconsin was preferable

because it would be more enjoyable.

then a complication arose: the two trips were on the same

weekend and the tickets were non refundable. Which trip would

you choose to go on?

Affect and Decision Making

Positive and negative outcomes feel different to us, with

predictable implications for the decisions we make. Affect thus is an

important determinant of decision making, and can have sizable

impact on psychological accounting process.

Hsee & Rottenstreich (2004) make this point by highlighting an

important dimension of choice that interacts with affect, which they

term scope; it basically refers to the sweep of a decision or action –

how much impact will it have? Consider

suppose you gave $10 to help save one endangered tiger---

feels good. Now much would you give to save 4 endangered tigers?

The answer depends on whether the subjective value you derive from

saving tigers is somehow multiplicative?

The authors propose a dual-process view of the relative impact of

scope and subjective value on decision making. Their dual processes

are – a deliberate mode (which would map into the conscious

reasoning) and an affective mode (which would map onto the

unconscious reasoning).

when we’re in a deliberate decision making mode, we value things by

calculation (4 > 2); while in an affective decision making mode we

value things by feeling (help tigers). In deliberate decision making

mode as scope increases subjective value increases correspondingly,

while in affective decision making mode scope doesn’t matter nearly

as much and we are affected by the presence/absence of a stimulus