Expected Utility Evaluation

  1. Who created the Allais paradox?
    Allais 1953
  2. What does the Allais paradox entail?
    • Choose between 2 for 2 bets:
    • 1A) 100% chance of £1 million OR
    • 1B) 89% of £1 million, 10% chance of £5 million and 1% chance of nothing 
    • 2A) 11% chance of £1 million and 89% chance of nothing OR
    • 2B) 10% chance of £5 million and 90% chance of nothing
  3. What does the Allais Paradox show?
    • When broken down, 1A & 1B both offer 89% probabolity of £1 million an 2A & 2B offer 89% probability of nothing, under the cancellation axiom these should be ignored meaning the choice is the same 
    • Both 2A & 2B also have a 1% chance of nothing and a 10% chance of £5 million 
    • The fact that these bets are the same means that any reasoning for 1 should be carried over with P's choosing 1A and 2A or 1B and 2B
    • This doesn't happen though, meaning people violate the independence axiom and do not reason using EU
  4. Who created the Ellsberg Paradox?
    Ellsberg (1961)
  5. What does the Ellsberg Paradox entail?
    • P's told there is an urn containing 30 red balls and 60 that are either black of yellow (quantities unknown) and the probability of selection is equally likely
    • 1A) £100 for drawing a red ball 
    • 1B) £100 for drawing a black ball
    • 2A) £100 for red and yellow
    • 2B) £100 for yellow and black
  6. What does the Ellsberg Paradox show?
    • If p's choose 1A over 1B they assume that the probability of choosing red is greater than that for black
    • This means the probability of red and yellow should be higher than black and yellow so they should choose 1A and 2A 
    • But they don't, this breaches the invariance axiom showing that people do not behave rationally as predicted by EU
  7. Who investigated preference reversal?
    Lichtenstein & Fischhoff (1977)
  8. What does preference reversal entail?
    • A) 80% chance of winning £2; 20% chance of losing £1
    • B) 20% chance of winning £9; 80% chance of losing 50p
    • P's then told they had tickets for each gamble and asked how much they would sell them for
  9. What does preference reversal show?
    • People tended to choose A but 81% of p's valued B as higher 
    • This violates the invariance principle
  10. Who created the asian disease problem? (not literally)
    Kahneman & Tversky (1981)
  11. What does the Asian Disease problem entail?
    Preparing for an outbreak of disease that will kill 600

    • Programme A) 200 are saved 
    • Programme B) 1/3 probability that all are saved but 2/3 probability that nobody is saved

    • Or choose between  
    • Programme C) 400 will die 
    • Programme D) 1/3 probability that nobody will die

    • 72% chose A and 78% chose D
    • This shows that simply framing something as a loss changes decisions and people are more interested in averting loss. By doing this they are violating the invariance principle
  12. Who supported the Asian disease problem?
    • McNeil et al 1982 
    • P's given info about surgery and radiation therapy for cancer and told in terms of mortality or survival rates 
    • 78% preferred radiation in the survival frame 
    • 58% preferred it in the mortality frame
  13. How do credit cards support the Asian Disease problem?
    Thaler (1980) 

    People are much less likely to use a credit card if they are told there is to be a surcharge than if they are told they will forgo a cash discount
  14. Who investigated psychological accounting?
    Tversky & Kahneman (1981)
  15. What does the psychological accounting study entail?
    Study 1:

    • You have decided to see a play. Admission is £10. On entering the theatre, you find you
    • have lost a £10 note. Would you still pay £10 for your ticket? 88% say YES

    • You have decided to see a play and have paid £10 for a ticket. On entering the theatre,
    • you find that you have lost it. Would you pay £10 for another ticket? 46% say YES

    • Study 2:
    • You are going to buy a calculator for £15 and a jacket for £125. A salesperson tells you
    • the calculator is on sale in another branch of the store 20 minutes drive away. Would
    • you make the trip? 68% say YES

    • You are going to by a calculator for £125 and a jacket for £15. A salesperson tells you the
    • calculator is on sale for £120 in another branch of the store 20 minutes away. Would
    • you make the trip? 29% say YES 
  16. How can we explain the fact that humans don't reason as expected by EU?
    • EU assumes that people have the mental resources acquired to reason rationally at all times, this is not the case though
    • People might be tired or distracted and are acting in a reasonable way given their mental capacity
Card Set
Expected Utility Evaluation