Prospect Theory & Context Effects

rule #1 of decision making

people act differently when making a decision is framed as a loss vs a gain

rule #2 of decision making

losses loom larger than gains

rule #3 of decision making

evaluations are driven by individual events, not total outcomes

risk-seeking

when the choices are perceived as losses (ex - deaths)

risk-averse

when the choices are perceived as gains (ex - lives saved)

endowment effect

when merely possessing an object increases its value

status quo bias

preference for the current state of affairs (the status quo) over change

loss aversion

people tend to be more sensitive to losses than to gains

gain framing

same situation framed as a gain is more favorable

reference points

determine whether something is coded as a “gain” or a “loss”

mental accounting

we put money into different “mental” accounts (e.g. rent money, car money, entertainment money)

prospect theory

the overarching framework for the three rules of decision making

• loss vs gain framing

• loss aversion

• individual events vs total outcomes are what matters