Decision Making and Expected Utility Theory

Decision Making

• Decision making involves cognitive processes to choose an action from a set of possible alternatives
• There are two types of decision making: preference-based and perceptual decision making

Expected Utility Theory

• An economic theory that describes how people make decisions to maximize their expected utility
• Decisions are analyzed in terms of acts, consequences, and states
• Acts: different actions a decision maker can take
• Consequences: different possible results of an act, which can be pleasant, unpleasant, or neutral
• States: all factors outside of the decision maker's control
• Utility: the degree to which a given consequence helps an individual achieve their goals
• Consequences that move us closer to our goals have positive utility
• Utility is subjective and can change over time
• Expected utility is the product of the utility of a consequence and its probability

Prospect Theory and Related Phenomena

• Risk aversion: people prefer less risk
• Loss aversion: people are more likely to want to avoid losses than gain wins
• Negative utility is stronger than positive utility
• Prospect theory explains risk aversion through the utility function
• Utility function: how the objective numerical amount of a product relates to subjective utility
• Decreasing marginal utility: the impact of an additional item decreases as the quantity increases
• Decreasing marginal disutility: the more losses hurt less than the first

Biases and Heuristics

• Framing effect: people make different decisions depending on whether the scenario emphasizes potential gains or losses
• Endowment effect: people over-value things they already own in comparison to what they don't own
• Default option bias: people tend to choose the default option even if it's not the best option
• Affect heuristic: people's tendency to make decisions based on their emotional reactions to different potential consequences
• Somatic marker hypothesis: people rely on emotional signals generated from their bodies for complex decisions

Emotion and Decision Making

• Ultimatum game: receivers tend to accept fair offers but not "unfair" offers, and are more likely to accept "unfair" offers when they believe a computer is making them
• Anger can change the goal from making the most amount of money to getting revenge
• Affect infusion model: emotional information is incorporated when appreciating consequences, acts, and consequences
• Mood maintenance hypothesis: people in happy moods want to maintain their mood, while unhappy people want to try to feel good