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This topic examines not just what goods and services consumers buy, but why they buy them. The standard neoclassical model, based on expected utility theory and indifference curve analysis, examines the ‘what’ question, but is too narrow in focus and involves numerous anomalies. To gain a better understanding of what people buy it is necessary to understand the psychology of consumers and examine the ‘why’ question. This approach reveals several important biases which cause the anomalies: biases in expectations, biases in estimating and maximizing utilities and biases in discounting. These biases are often a result of bounded rationality, social preferences and emotional or visceral influences. The field of behavioural economics has developed a body of theory, based on the concepts of prospect theory and mental accounting, which accounts for these biases and anomalies. The fundamental concepts here are the use of reference points and loss aversion. These and other behavioural factors are in turn based on evolutionary psychology. The process of natural selection has caused our brains to evolve not as utility maximising machines but as biological fitness maximising machines.
This chapter discusses prospect theory at length, as a prime example of the ways fairly trivial changes in the presentation of a set of facts can dramatically alter public opinion. The chapter begins with an ancient idea, at least as old as Aristotle’s philosophy, that in a public debate over an issue, features quite peripheral to the facts of a case could be invoked, challenged, or described in order to maximize an argument’s persuasive power. The central idea behind the art of political rhetoric is what we call framing. The conviction that framing is a powerful persuasive tool for political elites in both democratic and non-democratic regimes is widely held and, in many ways, contradicts rational choice models of decision-making. Because frames do not change the underlying dimensions of a choice – the facts of the case – they should not affect our decisions, at least not according to a rational choice framework. Still, they often do.
In a previously published article, I reported some tests of prospect theory's reflection effect over outcomes defined by money and life years gained from treatment. Those results suggested qualified support for the reflection effect over money outcomes and strong support over longevity outcomes. This article reruns those tests while accounting for the intensity of individual risk attitudes, and, overall, show consistency with the reflection effect. However, I argue that these results do not necessarily offer support for the explanatory power of prospect theory. Rather, the results may be driven by evolved responses to circumstances that provoke perceptions of scarcity and abundance. Therefore, from an ecological perspective, behavioral patterns such as those that are consistent with the reflection effect, which, by extension, tend to be considered as erroneous or biased by most behavioral economists because they conflict with the postulates of rational choice theory, may not be unreasonable. Recognizing as such is important when considering how behavioral insights ought to inform public policy design and implementation.
Why do some state leaders choose to escalate conflicts with close economic partners while others refrain? This chapter explores how a state’s perception of its relative position in a shared supply chain influences its response to conflict, by applying the psychological framework provided by prospect theory. When a state’s key industries are more dependent on the opponent within their shared supply chains, its leaders are more likely to escalate conflicts. This asymmetry in dependency makes policymakers see themselves as being in a strategically disadvantageous position, and the prospect of being replaced in the supply chains predisposes them towards more risk-seeking behavior. By contrast, when a state holds relative dominance within its shared supply chains, its leaders are less likely to risk conflict escalation. They perceive themselves as occupying a superior strategic position and will act in a relatively risk-averse manner to avoid further losses. This theoretical framework is employed to analyze two empirical cases: the ongoing trade conflict between South Korea and Japan and the conflict between South Korea and China over Terminal High Altitude Area Defense (THAAD).
Studies of prosumer decision making in the smart grid have focused on a single decision within the framework of expected utility theory (EUT) and behavioral theories such as Prospect Theory. This chapter studies prosumer decision making in a more natural market situation in which a prosumer has to decide whether to make a sale of solar energy units generated at her home every day or hold (store) the energy units in anticipation of a future sale at a better price. Specifically, it proposes a new behavioral model that extends EUT to take into account bounded horizons (in terms of the number of days) that prosumers implicitly impose on their decision making in arriving at “hold” or “sell” decisions of energy units. The new behavioral model assumes that humans make decisions that will affect their lives within a bounded horizon regardless of how far into the future their units may be sold. Modeling the utility of the prosumer using parameters such as the offered price on a day, the available energy units on a day, and the probabilities of the forecast prices, both traditional EUT and the proposed behavioral model with bounded horizons are ﬁt to prosumer data.
International investment tribunals often use the language of ‘rights’ to characterize foreign investors’ claims against host states, evoking the language of human rights and, in some cases, appearing to conflate the two concepts. We investigate the cognitive framing of the relationship between investor rights and human rights in investor-state dispute settlement (ISDS), as characterized by investment tribunals. We first establish that arbitrators (and scholars and counsel) tend to characterize investor claims as rights claims in general and property rights claims in particular, even if this normative basis is far from precise. Second, building on behavioural economics and cognitive psychology, we argue that this characterization places human rights considerations at a structural disadvantage in ISDS. Investor rights are perceived by arbitrators as endowments that are possessed and that risk being lost, while the human rights of host state populations are viewed as aspirational demands that might only be fully realized in the future. Thus, governmental actions interfering with investments are perceived by arbitrators as actual losses, while competing human rights claims are perceived as potential gains or demands. Following prospect theory, the former (certain losses) will usually be weighed more heavily in a decision-making calculus than the latter (possible gains). This loss–gain frame provides a cognitive explanation for the prevalence of arbitral decisions that prefer investor claims over human rights, a phenomenon that is highly problematic in times in which the legitimacy of the ISDS system rests on its ability to consider the rights of non-investors.
Originally developed by applying models from cognitive psychology to the study of foreign policy decision making, the field of behavioral IR is undergoing important transformations. Building on a broader range of models, methods, and data from the fields of neuroscience, biology, and genetics, behavioral IR has moved beyond the staid debate between rational choice and psychology and instead investigates the plethora of mechanisms selected by evolution for solving adaptive problems. This opens new opportunities for collaboration between scholars informed by rational choice and behavioral insights. Examining the interactions between the individual's genetic inheritance, social environment, and downstream behavior of individuals and groups, the emerging field of behavioral epigenetics offers novel insights into the methodological problem of aggregation that has confounded efforts to apply behavioral findings to IR. In the first instance empirical, behavioral IR raises numerous normative and philosophical questions best answered in dialogue with political and legal theorists.
Scholars of comparative constitution-making and direct democracy agree that economic conditions affect public support for constitutional reform but disagree as to how. Prospect theory suggests both approaches may be correct, depending on the political and economic context in which voters operate. Fourteen states periodically ask their citizens whether to call a state constitutional convention, making this the oldest form of direct democracy in the United States. We test our theory in preelection polls in two of these states and a survey experiment. According to the results, negative perceptions of economic and government performance increase support for conventions when voters view them as opportunities to correct problems. On the other hand, if a convention represents a chance to improve on an acceptable status quo, voters with positive performance evaluations become more supportive. Our findings contribute to the heuristics literature and inform normative debates over direct democracy and popular constitutionalism.
This chapter is to provide a succinct overview on the security challenges of UAV-based networks. To this end, we start by providing a general overview on the various security threats facing UAV systems, ranging from communication channel attacks to information attacks and Global Positioning System (GPS) spoofing attacks. Then, we develop, using game theory, a generic framework that can provide cyber-physical security for UAV applications such as delivery systems. We conclude with general remarks on the security of UAV systems.
Since Korea's transition to democracy in 1987, Korean leaders have become increasingly confrontational toward Japan, with such steps ranging from verbal threats filled with hawkish rhetoric to material threats, such as displays of military force and threats of actually using it. To explain South Korean leaders’ hawkish approach to Japan, we build a theory of “prospective diversion” by combining insights from the diversionary theory of international conflict and prospect theory. We argue that foreign policy leaders have a strong tendency to overvalue political losses relative to comparable gains in their approval ratings. As a result, they are inclined to take risk-seeking diplomatic actions toward foreign adversary to avoid further losses. By conducting statistical analyses and developing case studies of Korean leaders’ confrontational policy decisions regarding Japan, we present empirical findings consistent with our hypothesis that Korean leaders are inclined to engage in prospective diversion toward Japan when they suffer domestic losses. This article provides an enhanced understanding of the domestic political foundation of South Korean leaders’ increasingly contentious attitude toward Japan.
In the framework of a critical illustration of the contemporary history of economics, this chapter provides an (original) illustration of Hayek’s thought: his formative years, his contributions to the theory of the trade cycle and the theory of capital and the subsequent debates with Sraffa and Kaldor, his theory of the spontaneous order and of the market as a mechanism of knowledge diffusion, his political individualism and the similarities to and differences from the notions of methodological individualism, liberism and liberalism, his thesis on the denationalization of money.
Risk management tools are at the core of farm policy in many developed countries, and their effectiveness relies on the appropriate mechanism design. This study developed a gain-loss framework based on prospect theory to examine the reasons for the declining use of the main risk management tool offered to farmers despite growing volatility in returns. Using the administrative Ontario Farm Income Database (OFID) 2003 to 2013 and taking the beef sector as the example, this study found that the gain-loss framework predicts and explains the dynamic program participation pattern better than the conventional expected utility framework. Farms were found to be more likely to stay enrolled in the program when they experienced either larger gains or losses in revenue compared to previous years, suggesting that they were using the insurance programs both as an investment strategy (to seek government subsidies) and as a risk management tool (to protect against business risks), though the effects of revenue losses and hence risk management needs were stronger than gains. In addition, the program payment history and farm characteristics also shape the dynamic participation patterns. The findings increased the understanding of the drivers of withdrawal behavior associated with government-sponsored business risk management programs.
Information conveyed on the price tag or label of a consumable packaged good is widely thought to change the consumer's sensory experience of consuming the good. Can the positive “placebo” effects of high prices and negative “nocebo” effects of low prices on consumer experience be isolated and observed in a controlled experiment without using deception? In a pilot wine experiment using a method I call “half-blind tasting,” I observe that the nocebo response to a $5 price tag is stronger than the placebo response to a $50 price tag. To interpret these preliminary results, I borrow some insights from prospect theory. (JEL Classifications: C91, D81, L66, M31, Q11)
Although central to stakeholder theory, stakeholder value is surprisingly neglected in the literature. We draw upon prospect theory to show how stakeholder judgments of value depend crucially on the reference state, how there are several alternative reference states that may be operative when stakeholders judge value, how the choice of reference state for stakeholders’ value judgments can occur intuitively or deliberately, and how the level of the operant reference state may change with time and may also be incorrectly perceived by stakeholders or managers. Our theorizing results in a fundamentally different way of perceiving the value of corporate actions to stakeholders and shifts understanding of the avenues available for companies and others to influence stakeholder judgments of value. This novel perspective has implications both for theory and management practice, and not least for normative business ethics, if business is about stakeholder value creation.
Pathological gambling (PG) is an impulse control disorder characterized by excessive monetary risk seeking in the face of negative consequences. We used tools from the field of behavioral economics to refine our description of risk-taking behavior in pathological gamblers. This theoretical framework allowed us to confront two hypotheses: (1) pathological gamblers distort winning probabilities more than controls; and (2) pathological gamblers merely overweight the whole probability range.
Eighteen pathological gamblers and 20 matched healthy participants performed a decision-making task involving choices between safe amounts of money and risky gambles. The online adjustment of safe amounts, depending on participants' decisions, allowed us to compute ‘certainty equivalents’ reflecting the subjective probability weight associated with each gamble. The behavioral data were then fitted with a mathematical function known as the ‘probability weighting function’, allowing us to disentangle our two hypotheses.
The results favored the second hypothesis, suggesting that pathological gamblers' behavior reflects economic preferences globally shifted towards risk, rather than excessively distorted probability weighting. A mathematical parameter (elevation parameter) estimated by our fitting procedure was found to correlate with gambling severity among pathological gamblers, and with gambling affinity among controls.
PG is associated with a specific pattern of economic preferences, characterized by a global (i.e. probability independent) shift towards risky options. The observed correlation with gambling severity suggests that the present ‘certainty equivalent’ task may be relevant for clinical use.
This article seeks to establish a better scholarly understanding of former Russian President Boris Yeltsin’s decision to launch an ill-planned, risky, and ultimately disastrous invasion of the breakaway republic of Chechnya in 1994. Examining the decision-making environment that led up to the invasion, I conclude that while neorealism provides an adequate explanation for Yeltsin’s motives in this case, the decisions that he made in pursuit of these goals do not reflect the logic of rational utility maximization commonly associated with neorealist theory. Instead, I suggest that prospect theory – based on the idea that decision-makers tend to be risk averse when confronted with choices between gains while risk acceptant when confronted with losses – offers significantly more explanatory insight in this case. Thus, the article offers further support for an alternative theoretical approach to international relations that some scholars have termed ‘cognitive realism’, incorporating neorealist motives with a more empirically accurate perspective on the decision-making processes undertaken in pursuit of these motives.
Objectives: Prospect theory (PT) hypothesizes that people judge states relative to a reference point, usually assumed to be their current health. States better than the reference point are valued on a concave portion of the utility function; worse states are valued on a convex portion. Using prospectively collected utility scores, the objective is to test empirically implications of PT.
Methods: Osteoarthritis (OA) patients undergoing total hip arthroplasty periodically provided standard gamble scores for three OA hypothetical states describing mild, moderate, and severe OA as well as their subjectively defined current state (SDCS). Our hypothesis was that most patients improved between the pre- and postsurgery assessments. According to PT, scores for hypothetical states previously > SDCS but now < SDCS should be lower at the postsurgery assessment.
Results: Fourteen patients met the criteria for testing the hypothesis. Predictions were confirmed for 0 patients; there was no change or mixed results for 6 patients (42.9 percent); and scores moved in the direction opposite to that predicted by PT for 8 patients (57.1 percent).
Conclusions: In general, the direction and magnitude of the changes in hypothetical-state scores do not conform to the predictions of PT.
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