1. Decision Making choice… maximizing utility framing effects

2. Utility theory: A Normative Theory of Choice Each decision has associated costs and benefits. Costs and benefits are, to certain extent, subjective Most decisions carry certain amount of uncertainty or risk (probability that the expected outcome will occur) expected utility = subjective utility of a particular outcome * probability of the outcome Ideal decision makers should maximize expected utility that is, they should choose so to maximize benefits, and minimize costs Problems –It is tricky to assess expected utility (particularly for the future) –People do not reason this way

3. Calculating Expected Value (Expected Utility) P = probability of a particular outcome (ranges from 0 to 1) V = value of a particular outcome (the cost or benefit associated with the outcome) Expected Value = P x V If multiple outcomes are possible given a particular decision, then the expected value of all possible outcomes is added up.

4. Calculating Expected Value Suppose you get to choose between two different games of chance: (1) Winning $40 with probability.20 or (2) Winning $30 with probability.25 Which is the better choice?

5. Calculating Expected Value (1) Winning $40 with probability.20 The expected value of choice 1 is.2 x $40 = $8 (2) Winning $30 with probability.25 The expected value of choice 2 is.25 x $30 = $7.50 Choice 1 has the higher expected value. Another way to think about expected value is as “the average outcome over the long run.”

6. Another example of expected value: --What is the expected value of a powerball lottery ticket? --Largest powerball jackpot ever = $195,000,000 !! --Probability of winning the powerball 1 in 10,000,000,000. --The expected value:.00000000001 x 195,000,000 = 2 lousy cents.

7. Framing Effects - People’s tendency to be influenced by the manner in which choices are presented or framed. Choice A. Winning $40 with probability.40 people pick this Choice B. Winning $30 with probability.50 if both probabilities are doubled: A. Winning $40 with probability.80 B. Winning $30 with probability 1.00people pick this Certainty Effect: People tend to prefer sure gains (risk averse for gains)

8. Positive Frame Imagine that the US is preparing for the outbreak of an unusual tropical disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. The estimates of the program’s effects are as follows: Program A: 200 people will be saved. Program B: 1/3 chance that 600 people will be saved. 2/3 chance that 0 people will be saved. The expected value is the same for both programs

9. Negative Frame Imagine that the US is preparing for the outbreak of an unusual tropical disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. The estimates of the program’s effects are as follows: Program C: 400 people will die. Program D: 1/3 chance that 0 people will die 2/3 chance that 600 people will die.

10. Program A: 200 people will be saved. Program B: 1/3 chance that 600 people will be saved. 2/3 chance that 0 people will be saved. Program C: 400 people will die. Program D: 1/3 chance that 0 people will die 2/3 chance that 600 people will die. 72% of subjects pick Program A when the problem is framed in terms of “lives saved.” With the positive frame, subjects are “risk averse.” Negative FramePositive Frame Only 20% of subjects pick Program C when the problem is framed in terms of “deaths.” With the negative frame, subjects become “risk takers.”

11. Value losses gains }} A Hypothetical Value Function - “The pain of a loss is greater than the pleasure of a gain.” - “ small loses hurt (proportionally more) than big losses”

12. Cash or Credit?? $1.30/gal 5 cent discount for cash... $1.25/gal 5 cent charge for credit... Discount seems negligible, people use credit card. Surcharge is outrageous… people pay cash. gains losses

13. Framing effects are everywhere… What’s better? A basketball player who makes 75% of his free-throws, or one who misses 25% or his free-throws?

14. Justification Effects: Another Departure from Expected Value Theory Imagine that you are planning a vacation in a warm spot over spring break. You have two options…The travel brochure give only a limited amount of information about the two options. Given the information available, which vacation spot would you prefer? Spot A: average weather average beaches medium quality hotel medium temperature water Spot B: lots of sunshine gorgeous beaches and coral reefs ultra-modern hotel very cold water very strong winds

15. Spot A: average weather average beaches medium quality hotel medium temperature water Spot B: lots of sunshine gorgeous beaches and coral reefs ultra-modern hotel very cold water very strong winds Imagine that you are planning a vacation in a warm spot over spring break. You have two options…but you can no longer retain your reservation for both. The travel brochure give only a limited amount of information about the two options. Given the information available, which reservation do you decide to cancel?

16. prefer cancel total option A 33% 52% 85% option B 67% 48% 115% - Option B has features that allow subjects to justify a good or bad rating. - Thus, subjects decide by referendum on option B - How the question is framed, - emphasizes the (very) positive aspects of option B, or - emphasizes the (very) negative aspects of option B

17. Justification Effects: Last presidential election Kerry: Moderate on gay marriage Moderate on taxes Moderate on health insurance Unknown on Irak Moderate on Foreign Affairs Moderately religious Mixed message on abortion (personally opposes but Won’t legislate against it) Bush: Strongly opposed to gay marriage Strong ideas on taxes Strong ideas on health insurance Strong position on Irak Strong unilateralism Fervent religious Strongly oppose to abortion - Election was a referendum on the president - Both campaigns target Bush and try to frame him to their advantage - negative frame: anti-civil liberties, regressive taxes, mesianic, anti-choice - positive frame: moral values,tax relief, religious, pro-life

18. Justification: living with your decisions People make choices that they can justify to themselves (thus reducing regret) Even if those choices are sometimes irrational One last example: –you passed the exam -> you buy ticket to Hawaii (to celebrate) –You failed the exam -> you buy ticket to Hawaii (to cheer yourself up) –You don’t know whether you passed or you failed Logically, you should buy the ticket, but People are reluctant in this situation (no justification?)

19. Summary Utility theory fails to describe how people make decisions: –Frame effects –Influence of justifications (minimize regret)

20. Other issues Difficulty predicting future values –Wilson and Gilbert (on happiness) Peak and end assessment of pain Happiness (California) (Kahneman 1999)