Decision under risk and uncertainty (Utility measurement and Expected utility theory)

This week’s topic is very important because in our everyday life we are constantly making decision and many of these decisions involves certain risks. In most of day by day decision the probabilities are not known by the decision makers, which according to psychologists is known as decisions under risk and uncertainly. The academics normally express the uncertain events in numeral forms as odds probabilities and is quit difficult to assess the probability of an uncertain event or uncertain quantity. There are limited amount of heuristic principles, which reduces difficult tasks of assessing probabilities and values to a much simpler judgmental operations. However, even though these heuristics are useful they can sometimes lead to errors. Many risky decision making have taken a more quantitative approach and they assume that when individuals make a risky decision in reality what they are trying to do is maximise their expected value and expected utility. According to Hardman (2009), when it comes to expected value theory the probabilities and monetary problems can be determined by calculating the value of each possible outcome and weighting these outcomes by their probability of occurrence. On the other hand the expected theory the individuals are quite happy to pay a large sum of money due to the fact that there is an infinite expected value. Bernoulli (1954) suggested that individuals do not always behave as thought they are maximising expected value this is because while as a person’s wealth increases each extra unit of money adds utility but by less than the previous unit. It’s quite fascinating to learn that expected value theory believes that the rational decision maker should evaluate monetary outcomes by the probability of their occurrence, however, expected utility theory believes that rational decision maker should evaluate utilities of the outcomes by their probability of occurrence. The good thing about this theory (utility) is that it can be applied to other things rather than just money. However, the disadvantage is that it has not being measured directly and the neuroscience evaluation of the theory suggests that dopamine system responds to actual rewards and symbolic information (suggestion are based on human brain) (Hardman, 2009). Today I have learned that Utility and prospect theory do have things in common such as their integration and maximisation of something. Prospect theory is more concerned about the expectations rather than the monetary values. For example, if I have £10 in my pocket and someone promised to give me £100, however, she decided to give me £50 instead, which means that I am loosing because I expected to receive £100 from that person and I didn’t. Our reference point in prospect theory is our expected value. There is more explanation of the theory than evaluation. The graph below represents my utility function for money values ranging from £0 to £100,000

Fig 1



















Although, the graph suggests risk aversion but i still consider myself rational because i was trying to maximise my expected utility.

Fig 2



















I'm not really sure about the interpretation of the second graph but it seems almost perfect for risk taker.

Week 1 Introduction

Module introduction: 9/10/09

This week was mainly for general introduction to the module. We were told about the module assessment criteria and how we were expected to achieve this. Dr Hardman introduced his book “Judgment and Decision Making”, which by the way will cover the entire module plus the journals that he will post each week on his website. As third year student I would say his module is not entirely new to me due to the fact that for last two years he has covered few topics on heuristics and probabilities.

The second part of the lecture we discussed the subject by asking few of my colleagues about the meaning of judgment and decision making, as expected many of us had different opinion on the topic. However, it was very interesting to learn that although many of our opinion seemed to differ they actually come down to the same meaning. Dr Hardman then posed a question of ‘what is a good judgment? According to him, in order to consider or make a good judgment you need to consider all different types of information. You need to find out all the relevant information about them and then integrate this. However, by having too much information this might obstruct your judgment due to the time frame. Decision analysis is basically taking big problem and breaking it down into smaller problems. I have learned that one earlier stage of decision making is the weighting of the problems, the values and once you got that you then X these different things. This kind of decision is mostly made in government and big companies. However, some people suggest that a good decision is not always made in analytical ways.

Week 2 "Fast and Frugal Heuristics"

Fast and Frugal Heuristics

Judgment and decision making is possibly one of the most interesting topics within science of psychology. One might ask why is it so important to study or understand judgment and decision making. Well, certainly there will be different answers to this question, however, many will agree that judgment and decision making is part of our every day life. According to definition on Webster’s dictionary, on one hand, judgment is defined as “the mental or intellectual process of forming an opinion or evaluation by discerning and comparing” on the other hand, decision making is defined as “the act of settling or terminating …by giving judgment”. (Arkes et al, 2000)

So according to this definition judgment is seen as evaluation or estimates, while decision making indicates an intention to pursue a particular course of actions. Judgment and decision making are the two things that cannot be taken apart due to the fact that most of decisions we make are related to the judgments we make. As any science there are many different theories of judgment and decision making however, this week we analysed the Probabilistic Mental Models of judgment and decision making (PMM JDM). According to this theory when individuals are incapable to identify between two different alternatives they will then begin to search for cues that will help them to choose one alternative over another. This theory is known as Fast and Frugal Heuristics, which was developed by Gigerenzer et al. We might sometimes find ourselves in a situation where the time and our knowledge is limited to make certain decisions, so therefore, we use fast and frugal heuristics to help us make a decision. The central key of this theory is known as ‘take the best option and ignore the rest’. Although, we have learned that heuristics can lead to errors, Gigerenzer et al (2000) argue that heuristics are often of great importance. They believe that recognition heuristics is in fact one of the most important part of ‘take-the-best tactic because when we recognise one or more objects amongst another we then tend to give more value to the recognised objects.

In order to prove their theory Gigerenzer et al (2000), conducted experiment where they asked students to identify from different cities and decide which one of then has more population. As expected the students used their recognition heuristics to make decision, however, their experiment was criticised as being insignificant due to the fact that this could be the only information available for the participants at the time of decision making. Despite the criticisms fast and frugal heuristics (recognition heuristics and take- the- best) proved to be very useful even though the individual have little knowledge about the subject.