Showing posts from November, 2015

A comparison between Prospect Theory and Expected Utility Theory

Prospect Theory and Expected Value TheoryThe sub-field of judgment & decision making (JDM) in psychology studies the processes that humans undergo in order to make a decision. A particular area of interest revolves around choosing under uncertainty. The purpose of this essay is to define and compare two of the most relevant theories that cover decision making with risks. They are expected utility theory and prospect theory.
Expected Value Theory The first theory that will be covered is expected utility theory. This was developed by Daniel Bernoulli, a Swiss physicist and mathematician ("Daniel Bernoulli," n.d.). Before he developed it, expected value theory was what was commonly used instead. Its predecessor argues that in order to choose the best outcome on problems that involve money and risk we have to multiply the value of an outcome times their probability (Hardman, 2009). For example, if I bet fifty dollars that if I toss a coin it would land on heads, then, the exp…