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By Diogo Gonçalves Dear son, today I want to talk to you about how people make decisions. Many choices in our lives have uncertain outcomes. Choosing between two alternatives often involves a risk, such as whether you should spend your birthday money on a new bicycle or on a PlayStation. Each choice is like two sides of a coin: there is a [...]
Prospect theory is a behavioral model that shows how people decide between alternatives that involve risk and uncertainty (e.g. % likelihood of gains or losses). It demonstrates that people think in terms of expected utility relative to a reference point (e.g. current wealth) rather than absolute outcomes. Prospect theory was developed by framing [...]
Prospect theory proposes that when making decisions people use a reference point to frame prospective alternative outcomes as either potential gains or losses; when considering prospective gains, they are risk-averse and prefer certainty, but when considering prospective losses, they are risk-prone and prefer to risk the possibility of larger but uncertain losses. However, when setting prices people make decisions that contradict prospect theory: they are risk prone when cutting prices with the prospect of revenue gains, and risk averse when raising prices that they associate with perceived revenue losses.
Risk tolerance is often viewed as the core of risk preferences, which (along with time preferences and social preferences) are one of the cornerstones of preferences measured by behavioral economists (Falk et al., 2023). Risk tolerance shows how much uncertainty an individual is willing to accept to achieve a desired outcome, such as [...]
New research shows how our motivational need for an emotionally rewarding ending affects decision-making.
The disposition effect refers to investors’ reluctance to sell assets that have lost value and greater likelihood of selling assets that have made gains (Shefrin & Statman, 1985). This phenomenon can be explained by prospect theory (loss aversion), regret avoidance and mental accounting. Learn More More about the disposition effect on this website. [...]
Reference dependence is one of the fundamental principles of prospect theory and behavioral economics more generally. In prospect theory (Kahneman & Tversky, 1979), people evaluate outcomes relative to a reference point, and then classify gains and losses (see also loss aversion, endowment effect). Reference dependence can apply to any decision involving risk and [...]
Nudges are great, but they aren’t enough. While they are elegant, nudges are (often) just tweaks augmenting a pre-existing service or policy regardless of its quality, appropriateness or fitness. It is time to go from nudging to behavioral design.
In economics, utility (e.g. Stigler, 1950) refers to the benefits (satisfaction or happiness) consumers derive from a good, and it can be measured based on individuals’ choices between alternatives or preferences revealed in their willingness to pay. Behavioral economists have questioned past assumptions that utility is always maximized, and they have worked with [...]
‘Consequentialist’ perspectives of decision making under risk or uncertainty (risky-choice theories, see e.g. prospect theory) tend to either focus on cognitive factors alone or consider emotions as an anticipated outcome of a decision. The risk-as-feelings hypothesis (Loewenstein et al., 2001), on the other hand, also includes emotions as an anticipatory factor, namely feelings [...]
