PSY 214 - Judgment & Decision Making

Decision Making
• What are optimal decisions?
• Decision making behavior and judgment

What kinds of decisions
do people make?

What is a decision?
There must be…
1. A goal
2. Many ways to satisfy the goal
3. A consideration set (set of options being evaluated)
4. Some way of evaluating the options
5. Selection of one of the options

Where does the consideration
set come from?
• How do you order at a restaurant?
Environment ResearchMemory

What is a good decision?
• How do you know when you’ve made a good decision?
• What does this mean?
• Is it true – why or why not?
“Good decisions come from experience,
and experience comes from bad decisions.”

• Economists have worried about good decisions
• Rational decision making
o Consistent, ordered set of preferences; not affected by emotions
• Ex: Law of contradiction – reasoning processes that use
the same information should reach the same conclusions
o Those that do not are irrational
• Ex: Transitivity
o If you prefer A to B, and B to C
o Then you should prefer A to C

• Optimal choice
o Defined by an ideal or normative standard
o Normative models of decision making from economics

A brief foray into economics…
• Much research in the 1970s and 1980s was devoted to
comparing human performance to expectations of
economic models
• Two economic models of choice
1. Expected value theory
2. Expected utility theory

Expected Value Theory
• People calculate the potential value of each option
• Pick the option with the highest expected value
Raffle with 10% chance to win $5.00, 90% chance to win nothing
EV = (.10 x $5.00) + (.90 x $0.00) = $0.50

Expected Value Theory
• Ex: Which gamble would you rather play?
o A: 20% chance of winning $5.00
o B: 30% chance of winning $4.50
EV(A) = (.20 x $5.00) + (.80 x $0.00) = $1.00
EV(B) = (.30 x $4.50) + (.70 x $0.00) = $1.35
Expected value suggests that you pick option B

Problems with Expected Value
• Not every dollar has the same subjective value
o For financially dependent graduate student:
• $100 = new clothes, better food, etc.
o For a rich entrepreneur (e.g., Donald Trump):
• $100 would not need to be spent on necessities
• Ex: Lotteries
o People often play
o Pay $1.00 for a 1/52,000,000 to win $10,000,000
• Expected value of the gamble is much less than $1.00

Expected Utility Theory
• What can an option be used for?
• Consider the lottery example
o The expected utility of $1.00 may be low – what can you do with $1.00?
o The expected utility of $10,000,000 is very high
• Maybe the low probability of winning does not
completely outweigh the high utility of the prize
o The usefulness of earning money rather than the value itself
o There is even the pleasure of thinking about winning

Problems with Expected Utility
• The Allais Paradox
A: A 100% chance to win $1,000
B: An 89% to win $1,000
A 10% chance to win $5,000
A 1% chance to win $0
C: An 11% chance to win $1,000
An 89% chance to win $0
D: A 10% to win $5,000
Expected utility suggests that if you prefer A, you should prefer C
If you prefer B, you should prefer D

Allais Paradox
• A + C and B + D are the same!
B: An 89% to win $1,000
D: A 10% to win $5,000
A: An 89% chance to win $1,000
An 11% chance to win $1,000
B: An 89% to win $1,000
D: A 10% to win $5,000
A: An 89% chance to win $0
An 11% chance to win $1,000
B: An 89% to win $0
D: A 10% to win $5,000
A: An 11% chance to win $1,000
B: A 10% chance to win $5,000
An 89% to win $0
D: A 10% to win $5,000

Certainty Bias
• The Allais Paradox is an example of a certainty bias
• People often prefer the certain $1,000
o Also true in non-monetary situations
Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease,
which is expected to kill 600 people. Two alternative programs to combat the
disease have been proposed. Assume that the exact scientific estimates of the
consequences of the program are as follows:
Program A: 200 people will be saved
Program B: A 1/3 chance that 600 people will be saved, and a 2/3 chance that no
people will be saved
B: An 89% to win $1,000

Gains and Losses
• The previous example suggests that people are risk averse
for gains
o Do not want to risk losing a possible gain
o What happens for losses?
We are risk seeking for losses!
Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease,
which is expected to kill 600 people. Two alternative programs to combat the
disease have been proposed. Assume that the exact scientific estimates of the
Consequences of the program are as follows:
Program A: 400 people will die
Program B: A 1/3 chance that no people will die, and a 2/3 chance that 600
people will die

Disease Example
• Given: Disease – kills 600 people
o A(Gains): 200 will be saved
o A(Losses): 400 will die
• Gains: 0 + 200 = 200 (Great!)
• Losses: 600 – 400 = 200 (Not so great…)
400 people will die
200 will be saved

Framing Effects
• Kahneman and Tverksy
• People treat gains and losses differently
o The same situation feels worse when framed as a loss than when
framed as a potential gain

Framing Effects
• What if trays were removed from Eickhoff?
• E-mail from school administration
o Tray-less dining initiative to promote ecofriendly habits
o Removal of trays to prevent non-ecofriendly habits
• Which would you be more willing to accept?

Figure 4. Students in the positive framing condition reported
feeling satisfied with the changes significantly more than
those in the negative framing condition.

Context Effects
• Expected utility predicts that each option is evaluated
individually
o Adding more members to the consideration set should not influence
people’s preferences
• Attraction effect
o Imagine you are indifferent
between Brand A and Brand B
o What happens if a new brand
is added?

The Attraction Effect
• Brand C is
asymmetrically
dominated
o Higher price AND
lower quality than
Brand B
o Lower price AND
lower quality than
Brand A

The Attraction Effect
• New Coke = sales increase for Coke Classic

Compromise Effect
• Imagine C and B are
present
o People prefer B
• What about when A
is added?
o People prefer C, which
is a compromise between
A and B
o Confound:
Socioeconomic status

Single-Option Aversion
• What if the consideration set consists of only one option?
• This is less than ideal for most
o Need some means of comparison
o Perceptions of quality and price are made relative to one another
• You are looking to buying a new television
o A 32’ Samsung TV costs $200 at Target
• How comfortable are you with making the purchase?
o A 32’ Samsung TV costs $200 at Target, and $300 at Best Buy
• Which option do you pick?
• How comfortable are you with making the purchase?

Large Consideration Sets
• What happens when there are too many options?
• Say there are 50 different TVs you are considering, and
you want to compare prices at 20 different stores
• Frustrating and daunting
• Might opt out of the decision-making process

Choice Illusions
• What if consideration sets are merely illusions?
o Behavioral nudge – subtle suggestion to make certain choices
o Ex: Calorie listings on restaurant menus
• Dan Ariely (5:00) – opt-in vs. opt-out organ donation

Choice Anomalies
• Preference reversals
• Mental accounting
• House money effect

Preference Reversals
• Different measures of preferences may sometimes lead
to different outcomes
• When asked to choose a bet, people tend to choose A
• When asked how much they would pay, people tend to
give a higher price for B
A: 11/12 chance to win 12 chips
1/12 chance to lose 24 chips
B: 2/12 chance to win 79 chips
10/12 chance to lose 5 chips

Preference Reversals
• Very robust effect
o Slovic & Lictenstein did their study on the floor of a casino
• Compatibility effect
o Giving a price increases the weight given to the money prize
o Making a choice increases the weight given to the probability

Mental Accounting
• Utility theory is a common currency theory
o All options are evaluated with respect to utility
o But not all gains and losses are viewed the same
• Most people say they would go across town
o But if the jacket is $15 cheaper instead, most people would not
o Different mental accounts for different goals
Imagine you are shopping for a calculator and a jacket, and you find them both
at the same department store. The calculator costs $25, and the jacket costs $120.
You are told that the store across town has both items, but the calculator is $15
cheaper at that store. Do you buy the items at that store, or do you go across town?

Mental Accounting
• The idea is that people are creating separate mental
accounts for different goals
o Money for necessities
o Money for entertainment
o Spending money from one account does not affect others

Mental Accounting
• Yes – you haven’t already accessed the “ticket account”
• Maybe not – you have accessed the “ticket account”
Imagine you have gone to the movies to see a show. You go to the front
line and realize you lost $10. Do you still go to the movie?
Imagine you have gone to the movies to see a show. The ticket costs $10.
You buy the ticket early in the day. When you get to the theater, you
realize you lost the ticket. Do you buy another one?

The House Money Effect
• The tendency to take greater risks with profits
• You go to the casino and put a quarter into the slot
machine. You win $100.
o How is your gambling behavior affected?
• You are about to walk into a casino when you see a
newspaper. You own 100 shares of a stock and notice it
went up $1 that day.
o How is your gambling behavior affected?

Summary
• Economic theory affects psychological research
• Expected Value and Utility
o “Rational” models of decision making
o In many cases, people do not obey economic models
• We have discussed violations of economic models
o Next, we will discuss what people are actually doing…

PSY 214 - Judgment & Decision Making

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