Prospect theory: How people make decisions?

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We are risk averse and we dont want to loose anything and stay safe because homo sapiens (Modern Mankind) lived for millenniums in scarcity and poverty.

Resources were limited so that we are hesitated and anxious when we are making a decision.

People may buy things they dont want because they dont want to feel guilty because they missed a good offer.

Prospect theory is a subgroup of behavioral economics studies that describes how people choose between probabilistic alternatives when there is risk involved and the probability of different outcomes is unknown. 

This theory was developed in 1992 by Amos Tversky and Daniel Kahneman, who believed it was more psychologically accurate of how decisions are made than the expected utility theory. 

Under prospect theory, the underlying explanation for an individual’s behavior is that because the choices are independent and singular, the probability of a gain or loss is reasonably assumed to be 50/50 rather than the probability that is actually presented. Essentially, the likelihood of a gain is perceived to be higher. 

Tversky and Kahneman proposed that losses have a greater emotional impact on an individual than equivalent gains, so given two options with the same outcome, an individual will choose the option with perceived gains. 

Assume, for example, that the end result is receiving $25. One option is to be given $25 in cash. The other option is to be given $50 and then required to return $25. The utility of the $25 is the same in both cases. 

If you lost 10 USD you will feel horrible feelings and double the emotional effect of gaining a 10 USD.

The negativity of loosing is always stronger than the the positivity of gaining.

Individuals, on the other hand, are more likely to choose straight cash because a single gain is generally perceived as more favorable than initially having more cash and then losing it.

Prospect theory’s two stages :

Prospect theory is divided into two distinct phases: 

(1) editing and

(2) evaluation.

The editing phase refers to how individuals characterize options for selection.

 These are commonly referred to as framing effects. Framing effects demonstrate how the order, method, or wording in which a person’s choice is presented can affect the substance.

Beginning by the cheapest options then gradually going to expensive options will lead people to choose more cheap options but beginning the menu with expensive options then gradually going to cheap options make people feel afraid of missing a high quality option so they mainly choose a pretty expensive or average priced option. 

 The classic demonstration of this effect occurred in the so-called disease paradigm, in which people were asked to choose between public policy plans for dealing with a disease outbreak. Although the statistical probabilities remained the same.

Although the statistical probabilities remained the same, the percentage of people who supported a particular plan changed dramatically depending on whether the outcomes were presented in terms of the number of people who would live versus the number of people who would die.

The phrase 30% of people would die is rebelling you from choosing the program but a 70% chance of people will live does not have the same influence.

Real-world cancer patients chose between surgery and chemotherapy for treatment of their illness based on whether the outcome percentages were presented in terms of survival or mortality in perhaps the most dramatic demonstration of this effect.. People can easily see that the substance of the decision remains the same when presented with both options side by side, even if the psychic pull to perceive them differently remains.

Try to be rational and always remember that reasoning can saves us from unnecessary Purchases

“Prospect Theory – an Overview | ScienceDirect Topics.” Prospect Theory – an Overview | ScienceDirect Topics, www.sciencedirect.com Accessed 5 Aug. 2022.

Prospect Theory Definition.” Investopedia,, 22 July 2022,

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