Expected Utility Evaluation
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Who created the Allais paradox?
Allais 1953

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

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

Who created the Ellsberg Paradox?
Ellsberg (1961)

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

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

Who investigated preference reversal?
Lichtenstein & Fischhoff (1977)

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

What does preference reversal show?
 People tended to choose A but 81% of p's valued B as higher
 This violates the invariance principle

Who created the asian disease problem? (not literally)
Kahneman & Tversky (1981)

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

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

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

Who investigated psychological accounting?
Tversky & Kahneman (1981)

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

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