People evaluate outcomes relative to a reference point rather than in absolute terms, are loss-averse, show diminishing sensitivity, and overweight small probabilities.
A salary offer of $120,000 feels low if your reference point is $140,000 (your expectation) but high if your reference point is $100,000 (your current salary). The same objective outcome is evaluated differently based on the reference point.
Prospect theory tells you how you should decide—it's descriptive (how people do decide) not normative (how they should decide).
Thinking, Fast and Slow
Daniel Kahneman
Losses hurt approximately twice as much as equivalent gains feel good, making people risk-averse for gains and risk-seeking for losses.
Losses hurt approximately twice as much as equivalent gains feel good, making people risk-averse for gains and risk-seeking for losses.
Outcomes are evaluated relative to a reference point (usually the status quo) rather than in absolute terms, making framing crucial.
People overweight small probabilities and underweight moderate to high probabilities, with certainty being overvalued relative to near-certainty.
Outcomes are evaluated relative to a reference point (usually the status quo) rather than in absolute terms, making framing crucial.
What are the four key components of prospect theory?
Using prospect theory, explain why the same person might buy both lottery tickets and insurance.