Expected Utility Theory Quiz

<p>The individual is risk-averse. (B)</p> Signup and view all the answers

<p>More risk and uncertainty compared to Option B. (A)</p> Signup and view all the answers

<p>122 (C)</p> Signup and view all the answers

<p>Risk-averse individuals prefer smaller, more certain rewards. (D)</p> Signup and view all the answers

<p>It complicates the decision-making process. (C)</p> Signup and view all the answers

<p>Option A (B)</p> Signup and view all the answers

<p>They preferred a guaranteed amount over a gamble. (A)</p> Signup and view all the answers

<p>The probability of each outcome (C)</p> Signup and view all the answers

<p>The probable outcomes of a decision (B)</p> Signup and view all the answers

<p>Preferring lower risk options even if they yield lesser benefits (A)</p> Signup and view all the answers

<p>Expected utility considers individual preferences and the perceived value of outcomes. (A)</p> Signup and view all the answers

<p>Endowment effect (D)</p> Signup and view all the answers

<p>89% (B)</p> Signup and view all the answers

<p>Emotional attachment (C)</p> Signup and view all the answers

<p>Group 3 (A)</p> Signup and view all the answers

<p>Losses are felt more acutely (C)</p> Signup and view all the answers

<p>They preferred to gain the mug over chocolate (C)</p> Signup and view all the answers

<p>Greater regret in lost items (D)</p> Signup and view all the answers

<p>It increases the emotional attachment to the object (C)</p> Signup and view all the answers

<p>People are influenced by adding an irrelevant option to the choice set. (C)</p> Signup and view all the answers

<p>Only Option B is attractive due to higher range. (A)</p> Signup and view all the answers

<p>Price can be overshadowed by perceived value like range. (A)</p> Signup and view all the answers

<p>The chance of losing money is 40%. (A)</p> Signup and view all the answers

<p>Option C with a 25% chance of $33. (B)</p> Signup and view all the answers

<p>Higher monetary values directly correlate with lower chances. (B)</p> Signup and view all the answers

<p>Framing Effect (A)</p> Signup and view all the answers

<p>Higher range provides greater perceived value. (A)</p> Signup and view all the answers

<p>£500 for sure (D)</p> Signup and view all the answers

<p>400 people will die (C), 200 people will be saved (D)</p> Signup and view all the answers

<p>1/3 probability of saving none (A), 1/3 probability of saving 600 people (B)</p> Signup and view all the answers

<p>Both scenarios have the same financial risk and reward. (D)</p> Signup and view all the answers

<p>Losses are weighted more heavily than equivalent gains. (B)</p> Signup and view all the answers

<p>Option A is seen as riskier despite having a similar expected outcome. (A), Option B guarantees outcomes but is perceived as less attractive. (C)</p> Signup and view all the answers

<p>200 (A), 400 (D)</p> Signup and view all the answers

<p>The fear of loss often outweighs the potential for gain. (D)</p> Signup and view all the answers

<p>Decision-making under risk (C)</p> Signup and view all the answers

<p>Infrequently (A)</p> Signup and view all the answers

<p>Diminishing sensitivity to gains (B)</p> Signup and view all the answers

<p>Observing common patterns in financial behavior (C)</p> Signup and view all the answers

<p>They occur more often for small amounts. (A)</p> Signup and view all the answers

<p>Consumers typically have a preference for lower-value transactions. (B)</p> Signup and view all the answers

<p>Describes observed behaviors and patterns in decision making. (D)</p> Signup and view all the answers

<p>They leave accounts more frequently than they enter. (C)</p> Signup and view all the answers

The expected value (EV) of an option represents the average outcome you can anticipate if you were to repeat a decision many times. It is calculated by summing each possible outcome multiplied by its corresponding probability.

The expected value (EV) of an option is calculated by summing the products of each possible outcome and its corresponding probability. For instance, to find the EV of Option A with 80% chance of £4000 and 20% chance of £0, you'd calculate: (0.8 * £4000) + (0.2 * £0) = £3200.

The concept of expected value suggests that, logically, you should always choose the option with the highest expected value. However, in practice, people often deviate from this principle.

Risk aversion describes a tendency to prefer a guaranteed outcome, even if it means sacrificing potential for higher gains. This behavior implies that people are more sensitive to the pain of potential losses than the joy of potential gains.

The expected utility theory suggests that people make decisions based on the subjective value they assign to potential outcomes, rather than relying solely on objective expected value.

Kahneman and Tversky (1979) highlighted a common behavioral pattern known as 'risk aversion for gains.' This means that people tend to be more cautious when facing potential gains, often choosing options with lower expected value but greater certainty.

Risk aversion for gains implies that people often prioritize certainty and avoid taking risks, even if it means potentially missing out on larger rewards. This reflects a preference for minimizing potential loss.

Understanding risk aversion for gains helps explain why people often make choices seemingly contrary to objective expected value calculations. Their decisions are influenced by their individual risk tolerance and subjective value assigned to potential outcomes.

Expected Utility (EU) is a theory that suggests people make decisions based on the expected utility of each option, considering both the probability and the subjective value (utility) they assign to each outcome.

A concave utility function indicates that the value of additional gains decreases as you get more of something. This reflects risk aversion, where people are more sensitive to potential losses than gains.

Expected Utility Theory assumes that people are rational and make decisions based on maximizing their utility (expected satisfaction). However, real-world choices often deviate from this assumption.

The concept of diminishing marginal utility illustrates that the satisfaction gained from each additional unit of something decreases as you consume more of it.

The framing effect describes how the way information is presented can influence people's choices, even if the underlying options are objectively the same.

Prospect Theory, a behavioral economic theory, proposes that people value gains and losses differently, being more sensitive to potential losses than to equivalent gains. This explains why people might take more risks to avoid losses than they would to gain the same amount.

A decision-making approach where individuals choose the option with the highest expected value, calculated by considering the potential outcomes and their probabilities.

A psychological phenomenon, people tend to be more sensitive to potential losses than to potential gains.

A situation where people choose a smaller, certain gain over a larger, uncertain gain. This aligns with risk aversion.

A psychological phenomenon illustrating how framing a choice in terms of gains or losses can significantly influence people's decisions, often contradicting expected value calculations.

A psychological phenomenon where people overestimate the probability of events they can easily recall or imagine.

Prospect Theory is descriptive, meaning it aims to explain how people actually make decisions, rather than prescribing how they should make decisions.

Prospect Theory doesn't provide an answer to why the curves in the decision-making model are shaped the way they are. This is still a mystery.

People are more likely to take smaller amounts of money frequently, and larger amounts infrequently. Think of your own bank account - you probably make smaller deposits often, and larger deposits rarely.

People feel more pain from losing a large sum of money than the joy of winning a smaller sum. This explains why people might be more cautious when it comes to losing money.

The shape of the decision-making curve in Prospect Theory resembles the concave shape of a utility function.

The decision-making model based on sampling suggests that people make decisions based on how frequently they've seen similar situations in the past.

The endowment effect describes the tendency for people to value something more once they own it. This means they are willing to pay more to keep an item they already possess than they would be willing to pay to acquire it.

The endowment effect is the result of loss aversion, which means that the pain of losing something is greater than the pleasure of gaining something of equal value.

In the endowment effect, the value of an item increases once it becomes part of a person's possessions. This can lead to irrational decisions, as people might overvalue items they own, even if they are objectively worth less.

The study by Knetsch (1989) provides a clear example of the endowment effect. Participants who were randomly assigned a mug were more likely to keep it than to trade it for a chocolate bar, even if they had initially found both items equally appealing.

The endowment effect has implications for various economic situations, such as trading, pricing, and even negotiation. Understanding this phenomenon helps us analyze how people make decisions based on their possessions.

The steeper slope in the loss-aversion curve demonstrates that the negative impact of a loss is greater than the positive impact of an equivalent gain. This explains why people are more motivated to avoid losses than to acquire gains.

The endowment effect is related to other behavioral economic concepts, such as risk aversion and framing effects. These concepts highlight the influence of cognitive biases on our decision-making process.

The endowment effect can be mitigated by understanding its underlying principles and practicing strategies like thinking objectively about the value of items we own, considering potential gains instead of losses, and being aware of the potential for bias in our decision-making.

When people choose an option with a lower expected value because it comes with a higher certainty of getting a smaller reward, even if it means they might miss out on a larger potential gain.

A phenomenon where the attractiveness of an option is increased when another, clearly inferior option is present (the 'decoy').

The attraction effect can be used to create a sense of urgency or scarcity, making a product seem more desirable. It exploits the way our brains process information.

A concept that suggests people make choices based on their own subjective sense of value, not just on objective expected value.