Business Economics: Decision Making Under Uncertainty and Asymmetric Value Function - Prof, Apuntes de Negocios Internacionales

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• Business Economics 2014/
  • Term

TopicTopic 1:

The Individual as Decision MakerThe Individual as Decision Maker

Kahneman & Tversky

(Prospect Theory)

Daniel Kahneman, who wona Nobel Memorial Prize inEconomics for his work developing Prospect theory

Assymetric Value Function

Asymmetric Value Function:Asymmetric Value Function:

ImplicationsImplications

•^

Price-Framing: would you rather get a 5 EURdiscount, or avoid a 5 EUR surcharge?

-^

Associated Marketing Strategies:^ –

Segregate Gains

Segregate Gains

Combine Losses

Offset small loss with larger gain

Segregate small gain from large loss

Self-Control and Time-Consistency

•^

Defining truly “

irrational

” behavior in the

context of one decision is difficult

-^

It is less difficult in the context of

repeated

choicechoice

-^

If today you state that you prefer A over Btomorrow, then when tomorrow comes a rationalperson should choose A over B

-^

A failure to do so is called

time-inconsistency

Examples of Time-Inconsistency

•^

Fruit versus chocolate

-^

Gym membership

-^

Smoking

-^

Savings plan

-^

Savings plan

Commitment Device

•^

One way around the

time-inconsistency

problem

is to find

commitment devices

•^

These are

restrictions on future choices

that

force an individual to take a decision

that

force an individual to take a decision

•^

Notice that in

standard economics

, limiting

choice can

never

make an individual better off

Example 2: Freedom

Example 3: UlyssesExample 3: Ulysses

OutlineOutline

•^

Motivation

-^

Methodological individualism

-^

Cost-benefit analysis

-^

Theory of the asymmetric value function

-^

Theory of the asymmetric value function

-^

Decision making under uncertainty

Decision Making and Uncertainty

•^

The last idea we will cover in this topic isdecision making under uncertainty

-^

In many contexts, especially business, the exact payoff of a particular action is unknownexact payoff of a particular action is unknown

-^

When you invest money today, what will beyour payoff tomorrow?

-^

You know the distribution of payoffs, but notthe payoff that will be realized

Two Choices

•^

Suppose one investment will net €10,000 withprobability 0.99 and -€1 with probability 0.

-^

Another investment yields €0 for sure

-^

Suppose manager A chose the first and

-^

Suppose manager A chose the first and manager B the second

-^

Observing A netting -€1 and B netting €0 isnot sufficient to conclude B is a betterinvestor

Information Acquisition

•^

In some cases, the degree of uncertainty aboutan action’s payoff is something the decisionmaker himself can choose

-^

For example, I hope you made some effort to

-^

For example, I hope you made some effort to discover the implications of choosing UPFover other schools

-^

At the same time many people seem to notknow very much