1. Choices, Values and Frames
Bertan ESEN Meltem SEZER

2. OUTLINE
- What are the Choices, Values and Frames? - Risky and Riskless Contexts Risk aversion, Risk seeking - Psychophysical Approach - Prospect Theory - Decision Theory - The Psychophysics of Chance

3. What are the Choices, Values and Frames?
People do making decisions all the time, knowingly or unknowingly and analysis of decision making commonly distinguish risky and riskless choices.
And also these choices are related to values.

4. What are the Choices, Values and Frames?
Framing a decision is the process by which select areas of a situation are evaluated, explored, and then factored into the final decision.

5. What are the Choices, Values and Frames?
Framing a decision provides the foundation for how that decision will be made and is the first step in the decision-making process. The ‘‘framing effect’’ is observed when the description of options in terms of gains (positive frame) rather than losses (negative frame) elicits systematically different choices.

6. Risky and Riskless Contexts
Risky choices, such as whether or not to take an umbrella and whether or not to go to war, are made without advance knowledge of their consequences.
A typical riskless decision concerns the acceptability of a transaction in which a good or a service is exchanged for money or labor.

7. The Psychophysical Approach
The psychophysical approach to decision making can be traced to a remarkable essay that Daniel Bernoulli published in 1738.

8. To illustrate risk aversion and in Bernoulli's analysis;
Risk Aversion & Risk Seeking
To illustrate risk aversion and in Bernoulli's analysis;
Considering the choice between a prospect that offers an 85% chance to win $1000 (with a 15% chance to win nothing) and the alternative of receiving $800 for sure.
What would be your choice?
The expectation of the gamble in this example is .85 X $ X $0 = $850, which exceeds the expectation of $800 associated with the sure thing. The preference for the sure gain is an instance of risk aversion.

9. Risk Aversion & Risk Seeking
A preference for a sure outcome over a gamble called ‘Risk Aversion’ The rejection of a sure thing in favor of a gamble called ‘Risk Seeking’

10. A situation in which an individual is forced to choose between an 85% chance to lose $1,000 (with a 15% chance to lose nothing) and a sure loss of $800.

11. Prospect Theory
The most well-known formal theory, explains the framing effect in terms of the value function for goods perceived as gains and losses from a reference point. Whether an outcome is perceived as a gain or a loss depends upon the individual’s reference point, which is usually taken to the ‘‘status quo’’ asset level at the time of the choice.

12. Prospect Theory The value function shown as,
Defined on gains and losses rather than on total wealth.
Concave in the domain of gains and convex in the domain of losses.
Considerably steeper for losses than for gains.

13. Decision Theory
Modern decision theory can be said to begin with the pioneering work of von Neumann and Morgenstern (1947), who laid down several qualitative principles, or axioms, that should govern the preferences of a rational decision maker. Their axioms included transitivity and substitution,along with other conditions of a more technical nature.

14. Sample Problem 1:
(N = 152 respondants) 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 programs are as follows: ,
If Program A is adopted, 200 people will be saved.
If Program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved.
Which of the two programs would you favor?
(72%)
(28%)

15. Sample Problem 2:
(N = 155) If Program C is adopted, 400 people will die. If Program D is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die.
(22%)
(78%)

16. Sample Problem 3: (N = 86): Choose between:
E. 25% chance to win $240 and 75% chance to lose $760
F. 25% chance to win $250 and 75% chance to lose $750
It is easy to see that F dominates E. Indeed, all respondents chose accordingly.
(0%)
(100%)

17. Sample Problem 4:
(N = 150) Imagine that you face the following pair of concurrent decisions. First examine both decisions, then indicate the options you prefer.
Decision (i) Choose between:
A. A sure gain of $240
B. 25% chance to gain $1000 and 75% chance to gain nothing
Decision (ii) Choose between:
C. A sure loss of $750
D. 75% chance to lose $1000 and 25% chance to lose nothing
(84%)
(16%)
(13%)
(87%)

18. Psychophysics of Chance
Bernoullian expectation rule according to which the value, or utility, of an uncertain prospect is obtained by adding the utilities of the possible outcomes, each weighted by its probability. To examine this assumption, let us again consult psychophysical intuitions. Setting the value of the status quo at zero, imagine a cash gift, say of $300, and assign it a value of one.

19. Psychophysics of Chance
Now imagine that you are only given a ticket to a lottery that has a single prize of $300. How does the value of the ticket vary as a function of the probability of winning the prize? Barring utility for gambling, the value of such a prospect must vary between zero (when the chance of winning is nil) and one (when winning $300 is a certainty)

20. Sample Problem 5:
(N = 85): Consider the following two-stage game. In the first stage, there is a 75% chance to end the game without winning anything and a 25% chance to move into the second stage. If you reach the second stage you have a choice between: A. A sure win of $30 B. 80% chance to win $45 Your choice must be made before the game starts, i.e., before the outcome of the first stage is known. Please indicate the option you prefer.
(74%)
(26%)

21. Sample Problem 6:
(N = 81) Which of the following options do you prefer?
25% chance to win $30
D % chance to win $45
(42%)
(58%)
Prospect A offers a 0.25 probability of winning $30, and prospect B offers 0.25 X 0.80 = 0.20 probability of winning $45.

22. Sample Problem 7:
Imagine that you are about to purchase a jacket for $125 and a calculator for $15. The calculator salesman informs you that the calculator you wish to buy is on sale for $ 10 at the other branch of the store, located 20 minutes drive away. Would you make a trip to the other store?

23. Answer of Problem 7:
The potential saving is associated only with the calculator, the price of the jacket is not included in the topical account. The price of the jacket, as well as other expenses, could well be included in a more comprehensive account in which the saving would be evaluated in relation to, say, monthly expenses.

24. Sample Problem 8:
(N = 200) Imagine that you have decided to see a play and paid the admission price of $10 per ticket. As you enter the theater, you discover that you have lost the ticket. The seat was not marked, and the ticket cannot be recovered.
Would you pay $10 for another ticket?
Yes No
(46%)
(54%)

25. Sample Problem 9:
(N = 183) Imagine that you have decided to see a play where admission is $10 per ticket. As you enter the theater, you discover that you have lost a $10 bill.
Would you still pay $10 for a ticket for the play?
Yes No
(88%)
(12%)

26. Loses and Costs
Sample Problem 10: Would you accept a gamble that offers a 10% chance to win $95 and a 90% chance to lose $5? Sample Problem 11: Would you pay $5 to participate in a lottery that offers a 10% chance to win $100 and a 90% chance to win nothing?

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