The core ingredients: Acts, States, and Outcomes
Example: Decision problem = Should you have a barbecue in the park on May 20?
Sunny Rainy Barbecue Indoor
Sunny | Rainy | |
---|---|---|
Barbecue | \(O_{11}\) | \(O_{12}\) |
Indoor | \(O_{21}\) | \(O_{22}\) |
Sunny | Rainy | |
---|---|---|
Barbecue | 100 | 0 |
Indoor | 30 | 50 |
Sunny (.5) | Rainy (.5) | |
---|---|---|
Barbecue | 100 | 0 |
Indoor | 30 | 50 |
\[EU(A_i) = \sum U(O_{ij}) \times P(S_j)\]
The expected utility of having a barbecue (\(A_1\)) is:
The expected utility of not having a barbecue (\(A_2\)) is:
MEU recommendation: Have a barbecue
Value
Outcome
The value function
Decision weights
Value
Outcome
Imagine that Canada is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Which of the following two programs you would favour?
Loss as opposed to gain version:
Suppose I offered you a gamble in which I flip a fair coin and you call it in the air. If you’re right, you win $10, but if you’re wrong, you lose $10.
Would you play?
What does the minimum winning amount need to be for you to accept the gamble? (you still lose $10 if you are wrong)
Once people acquire something, they become reluctant to give up, even when offered a price they would not have paid for the object in the first place.
Sellers = $7 Choosers = $3
Gains | Losses | |
Small probabilities | Risk-seeking | Risk-aversion |
Medium and large probabilities | Risk-aversion | Risk-seeking |
Decision makers transform the objective probability of an outcome into a decision weight.
Problem 1. Choose between:
Problem 2. Choose between:
People place special emphasis on outcomes that are guaranteed to occur or guaranteed not to occur.
Consider a game of Russian roulette.
A shift from uncertainty to certainty is weighted more than an equivalent shift from one uncertain state to another.
People categorize money and resources according to their source and intended use, and often treat those categorized funds differently. One dollar is no longer equivalent to another.
You are on your way to the theatre. In your wallet, you have a ticket for which you paid $20, and a $20 bill. When you arrive at the theatre, you discover that you have somehow lost the ticket.
Would you spend your remaining $20 on a ticket?
You are on your way to the theatre. In your wallet, you have two $20 bills. When you arrive at the theatre, you discover that you have somehow lost one of the bills.
Would you spend your remaining $20 on a ticket?
You want to buy a car stereo. The dealer near your house sells it for $200, but if you drive across town, you can get it for $100. Would you drive to get 50% off (saving $100)?
You want to buy a car with a stereo. The dealer near your house sells it for $41,000, but if you drive across town, you can get it for $40,900. Would you drive to get .002% off (saving $100)?
100 coupons worth $.64 each One coupon buys one roll of dice. If total is 9 or more, get 5 coupons to cash in
Group 1: 1 envelop of 100 coupons
Group 2: 4 envelops of 25 coupons
Group 3: 10 envelop of 10 coupons
100 coupons worth $.64 each One coupon buys one roll of dice. If total is 9 or more, get 5 coupons to cash in
Played on average 43 coupons
Played on average 25.5 coupons
Played on average 16 coupons
Scenario 1: Mr. A wins two small lotteries in one day, one for $50.00 and one for $25.00. Mr. B wins one lottery for $75.00. Who do you think would be happier?
Scenario 2: Mr. A received a letter from the IRS saying that he owes $100.00. On the same day, he received a letter from the state tax authority informing him that he owes $50.00. Mr. B received a single letter from the IRS telling him that he owes $150.00. Who do you think would be more upset?
When we have two gain or loss experiences, we experience the steepest part of the curve — the part closest to the origin – twice
Recommendation: Segregate gains and combine losses
Mr. A and Mr. B both joined health clubs. Mr. A’s club charged a fixed fee for each month of usage, payable at the end of the month. Mr. B’s club charged an hourly fee for using the health club, with the total payable at the end of the month. By chance, both men used the health club about the same amount, and both ended up getting a bill for the same amount at the end of the month. Who enjoyed himself more while at the health club?
48% 14% 38%