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Expected Utility: A normative approach
In making decisions people are guided by various factors. Among them is utility theory
Basically this theory states that when faced with some type of uncertainty choice we make our decisions based two factors ; utility of the outcomes and their respective probability. Utility refers to whatever end a person would like to achieve e.g. happiness , money e.t.c Baron 1999) argues that utility refers to amount of good that comes out of a decision. It involves weighing the good that might come up out of each alternative.
Prospect theory: A descriptive approach
Kahneman & Tversky (1979) prospective theory as an alternative to utility theory
Prospective theory is a descriptive model of decision making.. It attempts to describe how we make decisions and why our decisions violate the expected utility model. According to prospective theory decisions are valued not based on absolute value of the end result as proposed by expected utility. Rather we value decision based on the amount of gain or loss from what we have now.
Another important feature of the model is that it proposes that gains and losses are on different scales of value. The value we attach on gains increases more slowly as functions of the size of the gain than of the negative (losses). Basically we feel losses more acutely than we do for the gains. The psychological pain that is associated with loosing is greater than the psychological pleasure of gaining. Therefore we tend to make decisions based on avoiding pain of loosing
Prospect theory predicts that our preference will change whenever our reference points changes.
If information is presented in terms of positive gains (gain frame)we will be more likely to avoid risks. However if the same information is presented in a negative lose frame e.g. emphasizing what we may lose we will be more likely to take a risk to avoid this loss. Framing is the term used to describe the effects of how a scenario is presented.
Chatelaine answered the question on June 17, 2021 at 13:08
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