Descriptive aspects of decision making

Summary Descriptive preference theories try to model intuitive decision-making behavior. There are many systematic deviations from behavior as predicted by utility theory. We will cover four systematic deviations: incorrect probability estimations, the Ellsberg paradox, reference point effects, and the Allais paradox. Descriptive preference theories provide the foundation for a wide range of economic models. You will learn about preference theories that extend expected utility theory and explain many of the deviations discussed. Cumulative prospect theory by Tversky and Kahneman (1992) is the most prominent descriptive preference theory. Its main attributes are reference point dependence, diminishing value sensitivity for gains and losses, loss aversion, and non-linear probability weighting. Many phenomena of everyday life can be explained by prospect theory. Other descriptive theories such as the disappointment theory or regret theory’s evaluation principles than does prospect theory. Descriptive insights into decision making also play an important role in prescriptive decision analysis. They not only help develop interview and analysis methods less prone to errors but are also relevant in interactive decision situations where rational decision making requires the correct anticipation of other players’ behavior.