psy 214 - judgment & decision making

Judgment andDecision 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 goal2. Many ways to satisfy the goal3. A consideration set (set of options being

evaluated)4. Some way of evaluating the options5. 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 conclusionso Those that do not are irrational

• Ex: Transitivityo If you prefer A to B, and B to Co Then you should prefer A to C


• Optimal choiceo Defined by an ideal or normative standardo 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 choice1. Expected value theory2. 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 $5.00o 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 valueo 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: Lotterieso People often playo 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 prizeo The usefulness of earning money rather than the value itselfo There is even the pleasure of thinking about winning

Problems with Expected Utility

• The Allais ParadoxA: A 100% chance to win $1,000

B: An 89% to win $1,000A 10% chance to win $5,000A 1% chance to win $0

C: An 11% chance to win $1,000An 89% chance to win $0

D: A 10% to win $5,000A 90% chance to win $0

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!

A: A 100% chance to win $1,000



D: A 10% to win $5,000A 90% chance to win $0

A: An 89% chance to win $1,000An 11% chance to win $1,000



D: A 10% to win $5,000An 89% chance to win $0A 1% chance to win $0

A: An 89% chance to win $0An 11% chance to win $1,000

B: An 89% to win $0A 10% chance to win $5,000A 1% chance to win $0



A: An 11% chance to win $1,000An 89% chance to win $0

B: A 10% chance to win $5,000An 89% to win $0A 1% chance to win $0



CL: Risky Decisions

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 situationsImagine 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 theconsequences 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 nopeople will be saved

A: A 100% chance to win $1,000


Gains and Losses• The previous example suggests that people are

risk averse for gainso Do not want to risk losing a possible gaino 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 theConsequences 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 600people 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 die200 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 habitso 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 individuallyo Adding more members to the consideration set should not

influence people’s preferences

• Attraction effecto Imagine you are indifferent

between Brand A and Brand Bo What happens if a new brand

is added?

The Attraction Effect• Brand C is

asymmetricallydominatedo Higher price AND

lower quality thanBrand B

o Lower price ANDlower quality than Brand A

The Attraction Effect

• New Coke = sales increase for Coke Classic

Compromise Effect• Imagine C and B are

presento People prefer B

• What about when Ais added?o People prefer C, which

is a compromise betweenA 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 comparisono Perceptions of quality and price are made relative to one

another

• You are looking to buying a new televisiono 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

https://www.youtube.com/watch?v=9X68dm92HVI



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 chips1/12 chance to lose 24 chips

B: 2/12 chance to win 79 chips10/12 chance to lose 5 chips

Preference Reversals• Very robust effect

o Slovic & Lictenstein did their study on the floor of a casino

• Compatibility effecto Giving a price increases the weight given to the money prizeo 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 utilityo But not all gains and losses are viewed the same

• Most people say they would go across towno But if the jacket is $15 cheaper instead, most people would

noto 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 goalso Money for necessitieso Money for entertainmento 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, yourealize 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 makingo In many cases, people do not obey economic models

• We have discussed violations of economic modelso Next, we will discuss what people are actually doing…

psy 214 - judgment & decision making

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