Issues in Making a Decision - Coursework Example

Making a Decision i) The EU (expected utility) theory is an economic theory, which s that a person faced with the task of making decisions compares the expected utility of the outcomes of the decisions that he or she wants to make. The decision maker should make choices between prospects, which can be termed as uncertain. The expected utility can be obtained by summing up the values of the utilities expected from the outcomes and converting them to the functions of the probabilities. The EU theory can be termed as crucial to the theory of economic behaviour. This emanates from the fact that economists employ this theory to create models of risk aversion. With the concepts proposed by this theory, it becomes possible for economists to exercise aversion to risks, which may be termed as large scale (Hastie & Dawes 2). ii) Human preferences may have an impact on the expected utility theory; in this regard, therefore, the choices that humans make may violate the expected utility theory. One example of how human preferences may violate this theory includes through judgements and biases. Personal judgment may affect the decisions made in that humans may at times fail to recognise the importance of the utility that can be derived from purchasing a certain product. There are times when the pattern of preference may be based on making a comparison of the value of the product to the intuition that the decision maker has. As a result, the decision maker ends up violating the rules of the market and making choices contrary to the expected utility theory (Hastie & Dawes 4). iii) Violation of the EU theory has some implications on the theory of decision making; this emanates from the fact that violating this theory influence the final decisions made. For example, violating the rules of the theory means that the decision maker will come up with a decision, which contradicts the market requirements. As such, a person may not make a decision based on priorities, as well as utility of the product purchased (Hastie & Dawes 8). #2 a) Framing effect refers to a scenario that emanates from equally explaining problems encountered in decisions, and when these descriptions contribute to varying decisions. Framing effects are commonly encountered when discussing decision making and they have an impact on rationality. The inconsistent and incoherent nature of human decisions can be said to emanate from framing effects. Based on the framing effect, the ability of the decision maker to tolerate risks is influenced by the choices available to the decision maker (Gilbert 6). b) Several empirical studies ascertain whether the decisions that people make are affected by framing effects. One such empirical study is “taxonomy of framing effects” conducted by Levin, Schneider and Gaeth in 1998. Under this approach, the researchers categorise framing effects into risky choice framing, attribute framing, as well as goal framing. The best model to use is the attribute framing in the explanations of framing effects. Based on this model, there is a description of the attributes of an object with regard to both the positive and negative traits of the object. The study subjects have to assess the objects described. The findings indicate that objects given positive description tend to get favourable evaluations; as opposed to objects described negatively, which receive unfavourable evaluations. The findings also indicate that there tends to be risk aversion, whereby people prefer to make decisions, which have few risks. c) People make choices, which will have little risks and avoid choices that have high risks. This explains why people consider the positive attributes and traits of an object while there is little consideration for the negative traits and attributes (Hastie & Dawes 12). #3 i) Loss aversion is a term used to refer to the fact that people feel more painful when they encounter a loss than when they experience some gain. Psychologically, losses tend to have greater powers than gains. In the field of economics, loss aversion entails a scenario whereby investors focus more on investments that bring losses while there is little focus on profitable investments (Hastie & Dawes 17). ii) Endowment effect is a notion, which means that people desire to have high demand for a product to the extent that they have high chances of relinquishing the product than they would contribute towards having the same product. An example when people would exhibit endowment effect by virtue of their behaviour is when they already purchase a product. For example, people tend to place an extremely high value on a product upon purchasing the product. This is because their property rights in the ownership of the product have already been established (Gilbert 10). iii) Based on the prospect theory, it can be argued that people exhibit endowment effect because they tend to fear losses and want to have maximum gains. As such, people tend to employ loss aversion when exhibiting endowment effect. in this regard, therefore, people do not want to encounter any losses, but maximize on what they do to ensure that gains exceed the possible losses (Gilbert 13). 4 a) Peak-end model refers to a phenomenon that determines the interpretation of situations, which happened in the past. Based on the peak-end model, the interpretation of an event largely depends on the intensity of the event, especially with regard to the period when the event can be regarded to have been at its peak. For example, through peak end model, people may have the tendency to remember past events such as visiting the dentist, or taking a delicious meal (Hastie & Dawes 22). b) An empirical finding that supports the main arguments in the peak-end model encompasses a study conducted by Kahneman and others in 1996. From this study, it is evident that human beings tend to remember events that either maximizes pain or pleasure. For example, they concluded that people tend to rate medical interventions with a lot of focus on pain. As such, people only describe how painful an experience with a doctor was even when they experienced little pain. c) In order to improve the customer’s memory of the restaurant, the meals can be improved considerably in order to make the customers come back and purchase from the restaurant. What can be done includes preparing delicious meals to the customers and serving the customers properly. Giving exclusive services to the customers will ensure that they come back (Hammond et. al. 8). 5) i) Focusing can be regarded as a form of cognitive bias, which relates to misjudgement in which there is excessive focus on some characteristics of a situation while some are avoided. Focusing illusion leads to errors in predicting the outcome of events, which will happen in the future. Impact bias occurs when people engage in the overestimation of how they will feel about an event, which may be emotional. In addition, impact bias may be experienced when there is a tendency to make wrong estimations of how long some events will happen. There tends to be similar causes for both impact bias and focusing illusion. These causes entail negative thoughts, emotions, as well as feelings towards something or some phenomenon. Impact bias and focusing illusion can also emanate from being subjective and lack objectivity while making assumptions (Hammond et. al. 10). ii) Several measures can be employed with the sole aim of mitigating impact bias and focusing illusion. Some of these strategies include being always objective and assessing situations properly in order to avoid erroneous judgements. Works Cited Gilbert, Daniel. Stumbling on happiness. New York: Knopf, 2006. Print. Hammond, John S, Ralph L. Keeney, and Howard Raiffa. Smart Choices: A Practical Guide to Making Better Decisions. Boston, Mass: Harvard Business School Press, 1999. Print. Hastie, Reid, & Dawes, Robyn. Rational choice in an uncertain world (2nd ed.). Thousand Oaks, CA: Sage Publications, Inc, 2009. Print. Read More