The Psychological study of decision making began after theories were introduced in order to understand an individual’s thought process when faced with decisions. The aim of these theories was to examine whether or not humans are rational decision makers by introducing probabilities and the evaluation of risk. This essay will evaluate The Expected Utility Theory, The Prospect Theory and other potential influences to decision making.
As well as state both the strengths and weaknesses of them, in order to determine how they have contributed to the understanding of human thought and decision making. The Expected Utility Theory has been the framework for evaluating an individual’s decision making in cases of risk and uncertainty for the last 50 years. (Barbera, Hammond, Christian, 2004). It states that individuals choose between risky prospects by comparing their expected utility values. This is done by adding the expected utility value of their potential outcome and multiplying it by the probability. Davis, Hands, and Maki, DATE? ).
This theory has widely been accepted as the model of choice, thus indicating that most rational people would not wish to violate the axoms of this theory, and it is also shown that not a lot of people do. This also influences the fact that humans are rational decision makers. In relation to this, a paradox was introduced in 1961 by Ellsberg, he suggested that the following experiment tests the Expected Utility Theory. A subject is asked to rank four bets on preference.
She or he is presented with two urns, each of the urns contain 100 balls in either black or red. There is no apparent information about urn B during the experiment, although urn A contains 50 red balls and 50 black balls. One of the balls is taken at random from each of the urns. The first bet is. ‘The ball that is drawn from urn A is black” and will then be denoted by AB. The second bet is that ‘The ball that is drawn from urn A is red and will then be denoted by AR, and we also have BB and BR.
If the individuals wins the bet, they are entitled to $100. This example shows that there is no probability measure apparent which support these preferences through the expected utility maximation. One explanation if this could potentially be, in case of the second urn (Urn B) the individual has very little information to form a decision, due to this, the individual will begin to take into account all possible outcomes. Thus taking into account the minimal expected utility while in the process of considering their decision.
In certain cases, the subject may consider all potential outcomes of urn B, in this case, the minimal utility of the bet AR and AB is $50, whereas the bets of BB and BR are $0. So this outcome is compatible with the maximum utility decision rule. This shows that the Expected Utility theory does indeed work, and influences whether or not individuals make the correct decisions. (Gilboa and D. Schmeidler, 1988) The Prospect Theory was introduced in order to show the major violations of The Expected Utility Theory, it was proposed by Hogarth in 1994.
This theory is important for analysing decision making under risk. It is also known to be the Normative Model of rational choice. is proposed to have two main elements, a decision weight function which is expected to analyse any weights which may be attached to the probability, and the value function which includes three characteristics: people experience losses and gains with complete different levels of intensity, people evaluate outcome with emphasis on the losses and gains and people are more sensitive to changes in the outcome the closer they become to the reference point (Oliveira, 2007).
When an individual chooses to make a decision which may involve risk, it can be seen as a choice between gambles or prospects. The following example shows the outcome of an individual violating the prospect theory (HOW? ) This example is based on responses from students at a University. They are presented with a hypothetical scenario of choice. The question that the students were presented with was: A 50% chance to win ? 000, 50% chance to win nothing. B: Winning ? 450 for sure. The subjects were required to imagine that they were indeed faced with this choice, and to indicate what decision they would have made.
The aim of this study was to discover how individuals reacted to decisions that appear to involve risk. These questions were given to the students in questionnaire form, these forms contained up to a dozen of similar questions. Kahneman & Tversky, 1979) The questionnaires varied in structure so they would be different every time, and the prospects would occasionally become reversed. Students at three different Universities were asked to take part in the experiment. The results from all three Universities appeared to be the same. This shows that the prospect theory is still used, and individuals prefer to choose the option that involves least risk when faced with a decision, which in turn refers to the question that humans are indeed rational decision makers.
Both the Expected Utility Theory and the Prospect Theory assume that all aspects of decision making is mechanical (Ray Crozier, Rob Ranyard, Ola Svenson, 1997) as these theories do not take into account social factors. Due to this, it is also important to consider other potential decision making influences. The Social Functionalist Approach is used in order to analyse the decision making structure (Leinhardt, 1977). This approach was introduced by Tetlock in 2002, In order to identify the importance of social factors during the decision making process. Michael W. Eysenck, Mark T. Kean, DATE? ).
In 1992 a study was conducted by Simonson and Staw, on the Sunk Cost Effect, during this study they analysed the effects of accountability in decision making. Some of the students that participated in this experiment were informed that their answers may be shared with instructors and other students, this was known as the high accountability condition. Other students were informed that their answers would be kept confidential, this was known as the low accountability condition.
The participants that had the high accountability condition were more likely to continue with their decision even if it was not effective, as they felt the need to justify their decision to the other individuals. This shows that individuals are likely to feel more pressure if they are presented with a decision which other individuals may be aware of. Conclusion: For years researchers and Psychologists alike have attempted to understand the thought process that goes behind decision making, and during this process theories were also introduced in order to make this understanding clearer.
The first major Theory was The Expected Utility Theory, which indicates that individuals are likely to choose the decision that is the most valuable, but although this is true, this theory can account for unnecessary risk taking, which in turn can cause an unwanted outcome. The Prospect theory on the other hand accounts for certain biases within decision making however this does not take into account other aspects of decision making, such as the probability and other potential influences.
The Social Functionalist Approach also shows that individuals are likely to feel pressured to make certain decisions, this may indicate that they are not making a decision based on what they believe, but rather what other people perceive as the correct decision. The Expected Utility Theory and Prospect Theory do show that although humans do appear to be rational decision makers in some sense, although this is not always the case, as there can be many things that can influence an individual’s decision, and due to this it is not possible to determine whether or not humans are indeed rational decision makers based entirely on theories.