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58 Cards in this Set
- Front
- Back
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SEU Economic Theory AXIOMS |
1. Completeness 2. Transitivity 3. Independence 4. More is Better |
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Completeness |
People can order all of the possible items inthe universe in terms of their utility for them. For any two items, people havea preference-- people have utilities, utilities can be measured, and theirmeasurement stays somewhat stable Must: Know all options, & have full information about these options |
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Transitivity |
If the utility of X>Z and Z>Y then X>Y---> this enables ordering; utilities do not flip flop and you can treat them as numerical entities |
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Independence |
Independence of irrelevant attributes -If the utility of A>B then A+Z > B+Z -It would not be useful in a rational theory for people to change their preference orders in the presence of another alternative -Subaru> Volvo so Subaru + toaster > Volvo + toaster |
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More is Better |
People prefer more to less In the economic framework, there is diminishing marginal utility but gaining always increases utility (diminishing marginal utility) |
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Indifference curves |
Economic model of trading off--- various points showing different combinations of two goods providing equal utility to the consumer |
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Multiattribute Utility Model (MAUT) |
House utility based on factors; House utility= u(size)x(size)+ (u)price(x)price, etc *It doesn’t matter what scale you use for u and x (utility -3 to 3, x's 1-10, etc) |
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NormativeModels |
How people *should behave given the environment *Should= to get themost from the market, not an ethical consideration |
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Descriptive Models |
How people behave |
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Bayes Rule |
Describes the probability of an event, based on conditions that might be related to the event--- conditional probability (Husband killed wife probability) |
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Pareto optimality |
No one can be better of without making someoneworse off |
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Market Failure |
When assumptions are violated (part of classical economics) -Lack of competition- price fixing, monopolies, oligarchies -Externalities- when people who are not related to the exchange are affected (usually negatively); There are many participants in the world who do not participate in the market- there are values that are hard to price like existence values over use values |
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Nudges are most needed when: |
-Cognitive resources are strained because of too much information, too little time, etc -The decision is new -Emotions, including morality and fear, are involved -The short-term and long-term goals are very different -There are automatic responses that interfere with the decision (eg the door handles in your Nudge charters) |
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Choice Architecture (NUDGES) |
iNcentives Understand mappings Defaults Give feedback Expect error Structure complexchoices |
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Gains/ Losses |
GAINS -Risk averse for gains -Certainty is preferred LOSSES -Risk seeking for losses |
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Pitfalls in Experimentation |
-Confounds- the thingyou want to measure differs along with something else so you can't discerncause or impact -Lack of validity- itdoesn’t measure what you think it does |
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Preference Reversals |
Whenyou ask people to price versus choose among (or rate) options, you getdifferent preference orders *Compatibility & prominence When pricing, people prefer the higher $ option When choosing or rating, people prefer the more certain probability bet; THUS it is impossible to make a preference ordering *Preferences are often constructed within a context |
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Procedural Invariance |
You should be able to evaluate the utility ofdifferent options, even if you change the way you measure it--- thisindifference curve should hold over a variety of procedures and contexts |
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Why do Preference Reversals happen? |
--Compatibility- People tend to weight information in the same metric as the response scale (if you are pricing, you often pay more attention to price) --Prominence- In qualitative models like choice (and rating) people pay more attention to the most important (prominent) attribute; prominent factor is often emotional like casualties |
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Prospect Theory |
Describes the way people choose between probabilistic alternatives that involve risk Explains: segregating/ integrating losses and gains and the Allais Paradox (even when EVs are the same, the specialness of the sure thing) |
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Why aren't price responses always rational? |
-They may use price as a cue to understand product value (luxury goods) -They sometimes get utility from saving or overspending based on the context -They treat price as a relative measure |
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Mental Accounting |
Price is supposed to be fungible! Money is money is money -We think of money as if it were in accounts -Sunk cost fallacy -Lottery win vs rebate -Perception of price Loss aversion + mental accounting= not being able to ignore sunk costs |
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Prices do not reflect true utilities-- they reflect contexts |
-The context of a high price might make people believe the product is better -The context of the proportion saved may indicate whether a deal is good or not -The context of the "account" the money is coming from will guide how they view the price |
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Separate versus Joint Preferences |
People make different choices when they evaluate choices separately or together. This violates procedural invariance and reflects preference reversals |
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Choice architecture |
Theorganizing of things can help influence decision-making |
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The path of least resistance |
Products/optionsthat make life easier will be favoured. Conversely, if something is complex anddifficult, then people are less likely to follow through e.g. insurance forms. |
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Heuristics |
Mental shortcuts that ease the cognitive load of making a decision |
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Anchoring |
The perceived value of something can besteered (or ‘anchored’) by an initial, sometimes irrelevant activity. Example: With charitabledonations, people give more if the options range from $100 up to $5,000 than ifthe options range from $50 up to $150. |
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Optimism andover-confidence |
We often over-estimate our abilities toachieve things. |
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Loss aversion |
‘Losing something’ is valued at least twiceas highly as ‘gaining something’. |
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Framing |
The contextualizing of an issue candramatically influence decision-making (e.g. when linked to either an anchor orloss aversion). |
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Status quo bias |
People tend to stick with their currentsituation that overcomes the inertia of change Ie- It’s easier to gain compliance to a medicationif people have to take it everyday. Thus birth control pills, that are onlyrequired for 3 out of 4 weeks, maintains the daily regime by using placebos for7 of the 28 days. |
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The emotionof decision-making |
Our emotional state can influence ourbehaviour (cf shopping on an empty stomach). Thus people in an aroused stateare more easily nudged. |
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Mental Accounting |
Moneyis money – yet we often seem to have different ‘mental accounts’ we dividemoney up into – which can lead to some poor financial decisions being made. Forexample we may have cash in the bank but still have money outstanding on acredit card. Also we treat pay-rises and bonuses differently. |
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Herd Behavior |
Welike to conform so are easily influenced by what others say and do (especiallyby those within the circle we wish to be associated with). Socialinfluence is one of the most effective ways to nudge behaviour. |
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Expected Value vs Expected Utility |
EV= Pr(S)xC EU=Pr(S)x(C)x u(S) In EU quantify the amount of satisfaction (UTILITY) we would derive from each option *Attitudes toward risk is expression y manipulating the utility function for U |
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Affect |
-Affective responses are primal -The physiology of the affect does not indicate the source -Lack of source information is another limitation of consumer cognition -Emotions are a necessary part of decision making |
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Negative Affect |
-Negative emotions are more differentiated than positive ones |
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Mood Effects on Decision-making |
Halo Effect Affect Heuristic- allows people to make decisions and solve problems quickly and efficiently, in which current emotion influences decisions. |
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Information seems representative if it is |
-Vivid -Memorable -Specific -Very matched to stereotype (not necessarily reality) |
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Conjunction Fallacy |
Sometimes A AND B seems more plausible than A or B. -Something very vivid, concrete, and plausible sounds more likely than something vaguely described, abstract, and hard to imagine *Availability heuristic- if it comes easily to mind, it seems more probable |
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Egocentric bias |
People believe that others are more like them than they actually are |
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Bias about outcomes |
Outcome bias- you look back and think it was inevitable Hindsight bias- You thought you knew it the whole time *Narcisism- we like to be right; we don't like dissonant information; we rationalize the unknown; we like sure things are underestimate the extent to which we didn't know |
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Overweighting Confirmatory Information |
People like positive and confirmatory information |
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Miscalibration |
People overweight small probabilities and underweight large probabilities *we are more sensitive to shifts around the reference point |
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Overconfidence |
*At low probabilities, we are overconfident 1. Over-precision in estimation Almost nothing is certain but we act like it is 2. Overestimates of self performance People overestimate their talent & abilities 3. Overestimate of self versus others People think they're better than average, esp at easier tasks |
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Power of Thinslice Judgements |
-They are often accurate -They allow is to figure out if someone is "fishy" or identify a bad idea -They are fast -They arise from our biology and experiences |
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Warren Harding Effect |
If someone looks like a role, you think they'd be good at it--> representativeness heuristic |
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IAT |
Implicit Attitudes Test Tests implicit attitudes by determining fastest recall (what neural connections exist) |
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Consequentialist Approach to Risk |
Obeys EU- the probabilities and outcomes are considered and they alone make up the utility |
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Non-normative Approaches to Risk |
Reactions to risk tend to be non-normative 1. Low probability verus high probability risk inconsistencies- overestimate low probabilities and underestimate high probabilities 2. Risk perception based on feelings and risk dimensions- anticipatory risk is not accounted for in EU (only anticipated emotions) 3. Social and cultural differences in response to risk- more at-risk communities perceive more risk |
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Most unsettling types of risk (low probabilities that sound bad) |
People perceive things as risker if they are dreadful and unknown - Dread risk- scary, catastrophic things -Unknown risk- new, not observable |
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Emotions and Cognition |
Emotions are primary and drive cognition (because source of emotion is hard to identify) |
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Risk Stigma |
People perceive things to be riskier if they violate their worldview Nudge people to accept stigmatized risk: -Change the mode: emotion looms less large in WTP -Change the name (rebrand- clean coal) -Wait a while and let the media attention die down |
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EU conceptualization of risk allows for |
Risk seeking and risk aversion behavior And focuses on the gain/loss by probability trade off and assumes constancy across the tradeoff (Actual risk is more complicated) |
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Actual risk is more complicated than the EU representation because: |
-People miscalibrate risks at high and low probabilities -Affect often proceeds cognition -Affect is driven by fear of dreadful and unknown risks, by culture, worldview, and by stigma |
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Endowment Effects |
You value things more highly because you own them |
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Disposition Effect |
It relates to the tendency of investors to sell shares whose price has increased, while keeping assets that have dropped in value--- Investors are less willing to recognize losses (which they would be forced to do if they sold assets which had fallen in value), but are more willing to recognize gains. |
