Two Ways to Study
Decision Making
• Rational Choice Theory
– Articulated by economists,
philosophers and mathematicians
– A normative approach: it
prescribes how people ideally
should make decisions
• Behaviorial Decision Theory
– Developed by psychologists and
cognitive scientists
– A descriptive approach - it
generalizes about how people
actually make decisions
Sample Claims within
Rational Choice Theory
• If you believe the Hoosiers have
a 75% chance of winning their
next game, then you must also
believe that they have a 25%
chance of losing it.
• If you prefer world music to rap
and prefer jazz to world music,
then you must prefer jazz to rap.
Sample Findings of
Behavioral Decision
Theory
• Jones may believe that:
– the Hoosiers have a 75% chance
of winning tonight
– although if the game goes into
overtime, they have only a 25%
chance of winning
– but, luckily, there is only a 50%
chance of the game going into
overtime
Violation of the
Probability Calculus
Let W be Winning
O be Overtime
and ~O be no Overtime
Then according to the Theorem for
Total Probability
Prob(W) =
Prob(O) x Prob(W/O) +
Prob(~O) x Prob(W/~O)
Another Example:
• Jones is the commander of 600
soldiers caught in an ambush.
An aide describes two possible
escape routes:
– If they take route A, 200 hundred
soldiers are likely to die.
– If they take route B, 400 are likely
to survive.
• “The choice is obvious”, says
Jones. “Clearly route B is the
best. Let’s get these guys out of
here.”
Framing Effects
• Jones’ mistake was to be misled
by how the decision was
framed.
• Investors in the stock market
exhibit lots of subtle framing
effects.
• In their book Why Smart
People Make Big Money
Mistakes, Gary Belsky &
Thomas Gilovich call such
cases examples where “When
six of one isn’t half a dozen of
the other”.
Overall Plan of this
Course
• We will begin with a unit on
Rational Choice theory. Here
we will supplement the
textbook with chapters from
other books posted on the web
site.
• Our text will provide most of
the readings for a unit on
Behavioral Decision Theory.
• We will then juxtapose the two
approaches and look at some
criticisms of each.
Terminological
Equivalents
• Although the content of
Rational Choice Theory is quite
stable, different writers use
different terms for basic
concepts. Here are some
synonyms:
– We must {decide, choose} from a
set of {options, actions}
– The anticipated {outcomes,
consequences, states of affairs}
resulting from our {decision,
choice} often depend on
- {contingencies, conditions, states
of the world} over which we have
no control.
Talking the Talk
• Jones’ aide presented two
{options, possible actions},
route A and route B.
• The {outcomes, consequences,
final state of affairs) as
described by the aide were
identical.
• The outcome of a bet on the
ballgame may well depend on
{contingencies,conditions,
states of the world} such as
whether it went into overtime.
Swim Ticket Decision
• A ticket allowing the bearer to
use a certain beach all weekend
costs $3 if purchased during the
week, while a single day’s
admission costs $2 if paid on
the day.
• Here is a matrix showing
possible purchasing actions,
various weather conditions, and
the consequences of
combinations of purchases and
weather.
Matrix for Swim Ticket
Problem
0 days 1 day of 2 days
of good good
of good
weather weather weather
Buy a
weekend
ticket
Pay $3
for 0
swim
days
Pay $3
for 1
swim
day
Pay $3
for 2
swim
days
Buy
daily
tickets
Pay $0
for 0
swim
days
Pay $2
for 1
swim
day
Pay $4
for 2
swim
days
Which Swim Ticket
Option Is Best?
• To decide between the options
we would ideally like to have a
weather forecast that would tell
us {the probability of, how
likely} each possible outcome
is.
• We also need to assign a {value,
desirability, utility} to each
outcome.
• Here are some plausible
assignment of probabilities and
relative values to the outcomes.
Assigning Probabilities
• From the weather forecast Jones
surmises that there is roughly a
50% chance of having exactly 1
day of good weather, 25% of the
weather being good all weekend
long and 25% chance that it will
be bad both days.
• Jones also assumes that the
weather is independent of
whether he buys a weekend
ticket or not!
Assigning Value
Numbers
• In evaluating each outcome,
Jones has to look at both the
cost of the ticket and the benefit
of getting to swim.
• For the moment, let’s assume
that each day of actual
swimming is worth $5 to Jones.
• In this case the overall value of
each outcome can be
represented as follows:
Matrix of Values
0 days 1 day of 2 days
of good good
of good
weather weather weather
Buy a
weekend
ticket
Buy
daily
tickets
-3
5-3
10 - 3
0
5-2
10 - 4