Choice and Decision
Greed/fear
Class Objective
• To understand nuances of human decision
making
Decision Theory
Decision theory is concerned with identifying the
values, uncertainties and other issues relevant in a
giv...
Choice under uncertainty
• Expected value
– Value X Probability
• Prospect theory states that people make
decisions based ...
Choice under uncertainty
• Heuristics: People often make decisions based
on approximate rules of thumb and not strict
logi...
Preferences
• Get a 100 rupee discount or avoid a 100 rupee
surcharge?
• Mall parking reimbursement or 20 rupee
discount?
...
Loss aversion
• loss aversion refers to people's tendency to
strongly prefer avoiding losses to acquiring
gains.
• endowme...
• IIMpact ‘merit pay’
• Insurance
Ratio of words starting with a K and those
having K later in the word?
• Availability heuristic
The ease with which a part...
• Representativeness
Stereotyping
Brand extensions
Conjunction fallacy – a combination of two is
more probable than just one
• Is the per capita income of Malaysia more
than $4000?
• How much is it?
• Anchoring and adjustment
• TV infomercials
• Heuristics are fast and frugal
1. Ambiguity effect – the tendency to avoid
options for which missing information makes
the probability seem "unknown.
2. ...
4. Choice-supportive bias – the tendency to
remember one's choices as better than they
actually were.
5. Clustering illusi...
Summary
• Decision Theory
• Prospect theory
• Bounded rationality
• Loss aversion
• Heuristics
– Availability
– Representa...
Further reading
• Cognitive Bias: Systematic errors in decision
making by Loren Gary, HBR
• Prospect Theory: An Analysis o...
?
Choice and decision
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Choice and decision

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Choice and decision

  1. 1. Choice and Decision Greed/fear
  2. 2. Class Objective • To understand nuances of human decision making
  3. 3. Decision Theory Decision theory is concerned with identifying the values, uncertainties and other issues relevant in a given decision, its rationality, and the resulting optimal decision. Bounded rationality is the idea that in decision- making, rationality of individuals is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision.
  4. 4. Choice under uncertainty • Expected value – Value X Probability • Prospect theory states that people make decisions based on the potential value of losses and gains rather than the final outcome, and that people evaluate these losses and gains using certain heuristics.
  5. 5. Choice under uncertainty • Heuristics: People often make decisions based on approximate rules of thumb and not strict logic. • Framing: The collection of anecdotes and stereotypes that make up the mental emotional filters • Market inefficiencies: These include mis- pricings, information asymmetry and non- rational decision making.
  6. 6. Preferences • Get a 100 rupee discount or avoid a 100 rupee surcharge? • Mall parking reimbursement or 20 rupee discount? • Which has a bigger impact on customer switching, price increase or discount?
  7. 7. Loss aversion • loss aversion refers to people's tendency to strongly prefer avoiding losses to acquiring gains. • endowment effect—the fact that people place a higher value on a good that they own than on an identical good that they do not own
  8. 8. • IIMpact ‘merit pay’ • Insurance
  9. 9. Ratio of words starting with a K and those having K later in the word? • Availability heuristic The ease with which a particular idea can be brought to mind
  10. 10. • Representativeness Stereotyping Brand extensions
  11. 11. Conjunction fallacy – a combination of two is more probable than just one
  12. 12. • Is the per capita income of Malaysia more than $4000? • How much is it? • Anchoring and adjustment • TV infomercials
  13. 13. • Heuristics are fast and frugal
  14. 14. 1. Ambiguity effect – the tendency to avoid options for which missing information makes the probability seem "unknown. 2. Backfire effect – when people react to disconfirming evidence by strengthening their beliefs 3. Bandwagon effect – the tendency to do (or believe) things because many other people do (or believe) the same
  15. 15. 4. Choice-supportive bias – the tendency to remember one's choices as better than they actually were. 5. Clustering illusion – the tendency to over-expect small runs, streaks, or clusters in large samples of random data 6. False-consensus effect – the tendency of a person to overestimate how much other people agree with him or her. 7. Forer effect or Barnum effect (astrology)
  16. 16. Summary • Decision Theory • Prospect theory • Bounded rationality • Loss aversion • Heuristics – Availability – Representativeness – Anchoring and adjustment
  17. 17. Further reading • Cognitive Bias: Systematic errors in decision making by Loren Gary, HBR • Prospect Theory: An Analysis of Decision under Risk by Daniel Kahneman and Amos Tversky
  18. 18. ?
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