MKTG102 Prospect Theory

risk preference

persons tendency to take risks or avoid them

expected value

EV = probability of outcome x value of outcome

• ie. lottery ticket with a prize of $1000 with a 1% chance of winning

• EV= $1000 × 0.01 = $10

• we value it at $10

risk averse

someone who makes decision with the least amount of loss

risk neutral

someone who makes decisions based on maximizing expected return/value with little concern over loss and uncertainty

risk seeking

someone who looks for the highest outcome regardless of risks

expected utiltliy theory

consumers evaluate the expected outcomes (utility) of different alternatives

• why? → whether we obtain the promised utility is uncertain

  • ie. buying a new brand with no prior experience, buying a product with known defect rates, investing in new tech

subjective expected utility

• idea that we make decisions based on the decision with the highest expected happiness and utility → personal and subjective, not just money based

• ie. option A: get $50, U = 8

• option b: 50% of $100, 50% of 0, U = 12

  • A-EU = 8, B-EU = 6

  • EU is higher for A, even though the cash amount is greater for B

prospect theory

• people evaluate gains and losses relative to a reference point

• diminishing sensitivity to increasing gains and losses

  • ie. happy after winning $100, if you were to win $200, youd feel happy but not twice as happy

    • inc/dec at sloped curve

loss aversion

• reactions and sensitivity to losses are more intense than reactions to gains of the same amount

• potential costs, efforts and sacrifices are weighted heavier than potential benefits and rewards

framing

describing the same info in different ways

• ie. of 100 people having surgery, 90 people live vs. 10 people died

• same thing is being said just how its described is different

attribute framing

• framing attributes to highlight positives or negatives

  • ie. beef with 5% fat vs 95% lean

• will depend on what consumers want → one is not better than the other

changing reference point

• trick in which you can present the same outcome between choices by changing the the baseline

  • ie. a ticket price $10 incurs an extra charge on weekend of $2

  • another is $12 but has a $2 discount on weekdays

    • → same thing is being described but the baselines are different so we can interpret it as a discount or an expense depending

status quo

current status → how things are right now

status quo bias

preference to keep things the way they are → avoids potential losses