9 page complete overview of ALL concepts discussed in the Judgement and Decision Making course of the Minor understanding and influencing decisions in business and society.
Minor Understanding and Influencing Decisions in Business and Society
Judgement and Decision Making
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Lecture 2 Loss aversion & Framing of decisions (prospect theory)
Expected Utility Theory EV = p*v
In order to calculate the utility of (uncertain) events
Theory argues people will maximize utility/happiness in any given
situation
Dominance principle Alternative gambles can be ranked from best to worst in terms of EV
Cancellation A choice between gambles should depend only on those outcomes that
differ
Transitivity If A>B and B>C than A must > C
Frequently framing breaks this – ie framing of loss of lives in gains/losses
even though rates are the same
Invariance Preferences must remain stable
*similar to above example
Description invariance Different formulations of the same problem must adhere to the same
preference order
Framing effect Framing something in specific ways influences how decisions are made
Prospect theory Decisions are dependent on context and thus are reference dependent
[ v(x-r) ]
Loss aversion The disutility associated with a loss of a given amount is larger than the
utility associated with a gain of the same magnitude
[ v(x) | < | v(-x) ]
Certainty effect People prefer certainty over uncertainty
Reduction of the probability of an outcome by a constant factor has
more impact when the outcome was initially certain than if it was
merely probable
Situation 5 from paper – a certain outcome vs a probable one
Pseudo-certainty effect People still favour ‘certainty’ even when the situation isn’t really certain
(like when it depends on previous uncertain situation)
Example from paper – situation 6 to situation 7 – where a “second
stage” was introduced
Hedonic editing Trying to max/min (dis)utility integrating/segregating gains/losses
Lecture 3 Mental accounting
Mental accounting Set of operations used by individuals or households to organize,
evaluate and keep track of financial activities
Minimal account Examining only the difference between two outcomes, disregarding
other features
Topical account Relates consequences of possible choices to reference level determined
(reference dependent) by context within which decision arises
$15 vs $10 pen example
Comprehensive account Incorporates all other factors including current wealth, future earnings,
possible outcomes of other probabilistic holdings etc.
Transaction utility Price – reference point [think of beer on beach example]
Acquisition Utility Utility you would get as if receiving the thing as a gift – the cost
, Disposition effect Investors keep losers too long and sell winners too early (loss aversion
and gain->risk-avers/loss->risk-taking; so hope that stocks go up
Sunk cost effect If a current account balance is negative likely to decide to do the thing
that makes account break even (e.g. go to concert)
Payment depreciation Gradual reduction of relevance of prior expenditure
Example of shoes – will try to wear them more times until cost is fully
depreciated
Payment decoupling Prepayment decouples the purchase from the consumption (you think
costs is less)
Credit cards are most prominent example
Piece-rating policy Paying per thing; link between consumption and purchase becomes
salient (seems more expensive)
This is why resort companies use “all inclusive” packaging
Fungibility of money Means that money is money and is replaceable by itself (MA violates this
assumption)
We consider money in different accounts to be “worth” different values
– also why ex: coffee money is not taken into account the same way
grocery money is
House money effect Prior gains can stimulate risk-taking
Myopic loss aversion Sensitivity to loss and tendency to evaluate their mental account often
Narrow framing When people do not look at the bigger picture of an account but keep
the open/close window small [e.g. cab drivers]
Diversification heuristic People diversify when making several choices at once
Money labels (1) Expenditures into budgets, (2) Wealth into accounts, (3) Income into
categories
Lecture 4&5 Heuristics & Biases
General information
System 1 Way of thinking that operates automatically and quickly, takes little to
no effort and has no sense of voluntary control; very intuitive
Accessibility The ease with which mental contents come to mind (expectations)
Natural assessment Attributes that are routinely and automatically produced by system 1,
without intention or effort (most important: evaluation of stimuli as
good/bad)
System 2 Way of thinking that allocates attention to effortful mental activities and
goes through a thought process
Stroop effect Blue: name the font colour: system 1 would say blue; system 2 would
say black
Inferred causality Because we are used to something, we automatically assume the same
(infer causality) (intuitively jumping to conclusions)
Halo effect Increases the weight of first impressions and taints our true perceptions.
First item has more impact
The order in which we process can influence the process
[e.g. grading essays]
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