Chapter 9 - Decision Making

Rational Ideal (Rational Choice Theory)

Economists argue that humans are rational thinkers and that we behave based on the Rational Choice Model based on the Expected Utility Theory

Rational Choice Theory

The classical view that we make decisions by determining how likely something is to happen, judging the value of the outcome, and then multiplying by 2

Prospect Theory

People choose to take on risks when evaluating potential losses, and to avoid risks when evaluating potential gains

Conjunction Fallacy

People think that two events are more likely to occur than either individual event

In reality, the probability actually decreases

Availability Heuristic

Items that are more readily available in memory are judged as having occurred more frequently

Media tells us about rare events, which impacts our interpretations and undermines the AH

Sunk Cost Fallacy

A framing effect in which people make decisions about a current situation on the basis of what they have previously invested in the situation

Framing Effect

People give different answers to the same problem depending on how the problem is framed

Representative Heuristic

Mental shortcut that involves making a probability judgement by comparing an object or event with a prototype of the object or event

Optimism Bias

People believe that, compared with other individuals, they are more likely to experience positive events and less likely to experience negative events in the future

Decision making + the brain

People with prefrontal damage making risky decisions stems from insensitivity to future consequences of their behavior

Means-ends Analysis

Process of searching for the means or steps to reduce the differences between the current situation and the desired goal

Analogical Problem Solving

Solving a problem by finding a similar problem with a known solution and applying that solution to the current problem

Sudden Insight + the Brain

Measured using Compound Remote Associates

High-frequency electrical activity seconds before solution came to mind (front part of right temporal lobe)

Increased activity in the anterior cingulate

Functional Fixedness

Tendency to perceive the functions of objects as unchanging

Constricts our thinking

Present Bias

Tendency for the present self to value the present outcomes more than future outcomes

Ex. snickers now vs. a week later

Hyperbolic curve for a future outcome such that estimated value is low until right before receiving the positive outcome (delay of gratfication)

Proportional Thinking

People often estimate value proportionally when they should estimate it absolutely

Ex. 3 in differences in elephants vs. in mice

Ex. Buying $1000 suit vs. $100 suit

Expected Utility Theory

Probability of outcome * value of outcome

Mistakes are made on both elements of the equation

Uncertainty Aversion

People dislike uncertainty

99% chance of winning 2M vs. 20% chance of winning $100

Endowment Effect

Sellers (value of losing smth) want more money from a product than buyers (value of gaining smth) want to pay