PROGRAMA DE PÓS-GRADUAÇÃO EM ADMINISTRAÇÃO
Consumer Behavior: An Analysis of Decision Under Risk
April 17, 2017
PhD Student Francisco Carlos B dos Santos
Ana A. Ikeda
Professor of Marketing Department – University of São Paulo
‘‘We begin with the premise that consumer research,
whatever form it might take, seeks to produce knowledge
about consumer behavior.’’
BOBBY J. CALDER
ALICE M. TYBOUT
Journal of Consumer Research, Vol. 14, No. 1 (Jun., 1987), pp. 136-140
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Expected Utility Theory
Classical Model
Whenever we try to explain the behavior of human beings, we need a framework
on which we can base our analysis. In economics, a structure based on two
principles is often used:
- Otimization: people seek to choose the best standard of consumption at there is
possible, and;
- Balance: the prices adjust until the total that people demand is equal to the total
offered.
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Homo Economicus = Rational consumer
• Always try to buy the best you can afford;
• Two ideas: preferences ("best") and restriction ("can pay");
• The budget constraint depends on consumer income and product prices;
• In most cases, the consumer has well-behaved preferences (that more you consume,
better, and you prefer a little of each good to unbalanced baskets).
• Economists do not know the preferences of all consumers for all commodities, but make
some assumptions to simplify the analysis:
- The preferences are complete (Given a set of baskets, the consumer can compare them,
setting their preferences)
- The preferences are transitive (if A > B e B > C, them A > C; if X ~ Y and Y ~ Z, them X ~ Z)
- The preferences are monotonic (the consumer is insatiable: in general, the more he has the
goods, the more satisfied he will be)
Source: Microeconomic (Hall R. Varian 6a. ed)
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Consumer preferences
• Economists represent preferences through the concept of utility = satisfaction / happiness
/ pleasure
• The relevance of the utility function comes from its ability to establish a ranking of the
baskets preferred by the consumer ("ordinal utility"), not its numerical value or level
("cardinal utility")
• Marginal utility of good X: how much does the level of consumer satisfaction increase
when consumption of good X expands by one;
• The marginal utility of a good decreases as its consumption increases.
Source: Microeconomic (Hall R. Varian 6a. ed)
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Indifference curves
• Indifference curve: set of baskets between which the consumer is indifferent (i.e., which generate the
same level of utility)
• The slope of the indifference curve is the marginal rate of substitution: it measures how much the
consumer is willing to give up one good to consume one more unit of the other, maintaining the same
level of utility (= subjective exchange rate)
When does Consumer Equilibrium occur?
TMS= Δx2/Δx1
Δx2
Δx1
Source: Microeconomic (Hall R. Varian 6a. ed)
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x1
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•
The consumer is considered to be in equilibrium
when he can no longer improve his situation by
going to the market to exchange his goods;
•
This happens when the value of a commodity (in
relation to the others) is exactly equal to how
much the market attributes of value between the
goods: that is, if it sells one at the market rate to
buy the other, also at the market rate , It stays the
same;
•
Therefore, the consumer always looks at the
relative price of the goods, and compares it to the
value that he himself attributes to the goods
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Theory of Choices Involving Uncertainties in the Classic Model
The property of invariance determines that in any decision-making process, the preference for a certain
course of action should not be influenced by the way the problem is presented to the decision maker,
that is, different representations of the same problem with respect to the characteristics of options,
results and probabilities, should generate the same preference.
This principle is almost a precondition for any model of choice that is intended to be normative.
• In this way any probabilistic judgment (uncertainty) must be rational and consistent with
these theories.
• The pioneering studies by Tversky and Kahneman (1979) indicate that this rationality does
not occur in the way that the Microeconomic Theory postulated until then.
• However Kahneman and Tversky argue that precisely because the axioms of invariance
and dominance are normatively essential and descriptively invalid, it follows that "a
rational decision theory can not provide an adequate description of choice behavior."
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Theory of Choices Involving Uncertainties
Experiments on the Theory of Expected Utility
• Kahneman and Tversky have conducted empirical tests regarding expected utility theory applied to
simple decision problems in volunteers.
• The "rational" answer to each question is pre-determined and then compared to the respondent's
response (students from the University of Stockholm and the University of Michigan).
• The following examples illustrate the application of this research strategy in a problem that is part of
the set of evidences that indicate violations in the theory of expected utility.
Problem 1: Imagine that you should make a choice in each of the following situations:
SITUATION 1 (Problem 1)
A: win $2.500 with probability of 33%
B: win $ 2.400 with probability of 100%
win $2.400 with probability of 66%
win $0
with probability of 1%
Result
N = 72
[18%]
[82%]*
* p<0,01
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Theory of Choices Involving Uncertainties
Experiments on the Theory of Expected Utility
SITUATION 2 (Problem 2)
C: win $ 2.500 with probability of 33%
win $ 0
D: win $ 2.400 with probability of 0,34%
with probability of 67%
win $ 0
with probability of 66%
Result
N = 72
[83%]*
[17%]
* p<0,01
•
In this problem, most respondents choose the B-C combination. However, this pair of choices is
inconsistent with the theory of expected utility because it means that:
•
Situation 1:
u($2.400) > 0,33*u($2.500) + 0,66*u($2.400) ou 0,34*u($2.400) < 0,33*u($2.500)
•
Situation 2:
0,34*u($2.400) > 0,33*u($2.500)
Conflicting situation since the two experiments are equal in terms of utility !!!
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Theory of Choices Involving Uncertainties
Experiments on the Theory of Expected Utility
Problem 2: Imagine that you should make a choice in each of the following situations:
SITUATION 1 (Problem 3)
A: win $ 4.000 with probability of 80%
B: win $ 3.000 with probability of 100%
Result
N = 95
[20%]
[80%]*
SITUATION 2: (Problem 4)
C: win $ 4.000 with probability of 20%
D: win $ 3.000 with probability of 25%
Result
N = 95
[65%]*
[35%]
* p<0,01
Again we note that:
In the situation 1: u($3.000) > 0,80*u($4.000) , however
In the situation 2 we have the opposite 0,20*u($4.000) > 0,25*u($3.000) although the probability of D is
greater (which contradicts the presupposition of rationality)
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Theory of Choices Involving Uncertainties
Experiments on the Theory of Expected Utility
Problem 3: You must make a choice in each of the following situations now involving nonmonetary choices:
SITUATION 1: (Problem 5)
A:
Win a 3-week vacation trip to England,
France and Italy
N=72
50%
B:
Win a vacation week in England
[22%]
100%
[78%]*
SITUATION 2: (Problem 6)
C:
N=72
Win a 3-week vacation trip to England,
France and Italy
5%
D:
Win a vacation week in England
[67%]*
10%
[33%]
Again the expected result would be the choices of B and D and not B and C because:
Situation 1: u(B) > 0,50*u(A), however in the situation 2 0,05*u(C) > 0,10*u(D) which contradicts the
hypothesis of the substitution axiom.
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Theory of Choices Involving Uncertainties
Experiments on the Theory of Expected Utility
Problem 4: You must make a choice in each of the following situations, but with almost zero probability of occurrence.
SITUATION 1: (Problem 7)
A:
Win $ 6.000
45%
B:
N=66
[14%]
SITUATION 2: (Problem 8)
C:
N=66
Win $ 6.000
Win $ 3.000
90%
[86%]*
0,1%
D:
[73%]*
Win $ 3.000
0,2%
[27%]
Again the expected result would be the choices of B and D and not B and C because:
Situation 1: 0,90*u($3.000) > 0,45*u($6.000), however
In the situation 2: 0,001*u($6.000) > 0,002*u($3.000) which contradicts the hypothesis of the axiom of
substitution.
The choice made in 2 despite the event being almost unlikely people chose the one with the highest gain.
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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The Reflexion Effect
• Will the results presented in the previous experiments have the same behavior when the
gains are replaced by losses?
Yes. Again the results indicate that the principles of expected utility have been violated.
Overestimation of uncertainty decisions:
• Favors risk aversion in the field of earnings (certainty effect) and;
• Risk-prone (risk taker) in a losing ground (Myopic Aversion to Losses - Reflexion Effect).
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The Certainty Effect and Myopic Loss Aversion
• An important example of a violation of the expected utility theory is the certainty effect.
This effect occurs when, faced with a situation of choice between an alternative of right
result and another of possible outcome, the right option gains an extremely greater
importance.
• Thus, the weight given to the right result is much greater than the weight given to the
likely outcome in weighing the results by their probability of occurrence for decision
making. This happens, in general, even though the expected gain of the possible scenario
is greater than the gain considered certain.
• The exaggerated weight given to the right result can happen for both the profit domain
and the loss domain. But situations involving losses have inverse results: when the loss is
certain, the option where loss is only a probability is preferred.
• Thus, in situations involving 2 options with probabilities, the one with the least likelihood
of loss is preferred. This inverse behavior of risk aversion when there is gain involved and
risk propensity when there is possibility of loss is known as a reflection effect.
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O Probabilistic Insurance
Experiments on the Theory of Expected Utility
Problem 5
(Problem 9): Imagine that you are considering buying residential insurance against damage (theft or fire for
example). After analyzing the costs and the risk in having or not the insurance you were indifferent between having or
not. But there is an insurance option that gives you insurance based on probability. In this insurance you will pay only
half the premium amount (cost). In case of an accident, there is a 50% chance that you will pay the other half of the
premium and the insurance will cover all damages and there is a 50% chance of receiving the money back and taking the
risk of loss alone (the insurance does not Will cover the damages). For example if a claim occurs on an odd day of the
month you pay the other half and the insurer covers the losses; However if the accident occurs on a couple day you
receive the 50% and the insurer will not cover the losses. Remember that the premium for full coverage is such that for
you it is greater than the costs. Under these circumstances would you hire probabilistic insurance?
N=95
Sim
Não
[20%]
[80%]*
As noted in the example, the certainty and reflection effects imply risk aversion on the positive side - since
there is a preference for the right gain - even if the likely option gain is greater. On the negative side - when
there is loss involved - on the other hand, there is a risk tendency, since the option is preferred where there
is probability of loss, even if it is a loss greater than the other option.
Thus, it is noted that both the loss aversion and the desire for gains are intensified when there is
certainty.
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Isolation Effect
• Another form of violation of theory is the isolation effect, whereby people tend to isolate
the characteristics of alternatives so as to simplify them to facilitate the process of choice.
- Different characteristics  greater focus
- Common features Ignored
• The effect can be observed in scenarios whose alternatives have the same result but with
different intermediate steps or values.
Problema 6
(Problem 10): Consider a two-stage game. In the first stage you have a 75% chance of finishing the game
without gaining anything and a 25% chance of going to the second stage. If you reach the second stage you will have the
following options: ($ 4,000; 80%) or ($ 3,000; 100%). You must choose which of the two paths you will follow before
starting the game.
[75%]
Formulação
padrão
Standard
formulation
Formulação
sequencial
Sequential
formulation
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Isolation Effect
• Thus, instead of considering only the final result, greater importance is attached to the
gains and losses. Thus, changes in wealth seem to matter more to individuals than the
final state.
• The previous game can be summarized as follows:
- 0,25 * 0,80 = 0,20 to win $4.000 [75% chosen this option]
N=141
- 0,25 * 1,00 = 0,25 to win $3.000
Problema 7: Suppose you have a certain monetary value and must make one of the choices below:
SITUATION 1: (you won $1.000) (Problem 11)
A:
N=70
Win $ 1.000
50%
B:
[16%]
Win $ 500
100%
[84%]*
SITUATION 2: (you won $2.000) (Problem 12)
C:
N=68
Lose $ 1.000
50%
D:
[69%]*
Lose $ 500
100%
[31%]
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Prospect Theory
New Explanation for Utilitarian Theory
•
•
•
Again the rational choice would be B and D, but B and C were chosen.
The evidence again indicates the reflexive effect where there is an aversion to the right gain and a risk propensity for
losses.
This would explain why exchange traders make a quick profit in the market even if the indicators show that the bullish
trend will persist and a propensity to remain poised when the market is declining.
An important feature embedded in expected utility theory is the issue of risk aversion to monetary outcomes, whereby a
person prefers a certain perspective to any uncertain perspective with the same expected outcome.
People do not structure problems holistically and comprehensively as expected by theory, and they do not process
information according to the expected rules (SCHOEMAKER, 1982).
Thus, the theory of expected utility would need to adapt to the evidence that individuals do not follow the pattern of
rational behavior, with the preferences and beliefs expected by theory.
Thus Kahneman and Tversky propose a new explanation known as Prospect Theory. In this way, a decision problem is
defined by three elements: options or acts between which the individual must choose, possible outcomes, or
consequences of these acts, and contingency of the probabilities of the results. The authors use the term decision frame
to refer to "the decision maker's conception of the acts, outcomes, and contingencies associated with a particular choice".
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Prospect Theory
New Explanation for Utilitarian Theory
•
Classical Theory of Expected Utility: the assessment of the perspectives for decision making uses only
the final state of the individual's wealth;
•
Prospect Theory: the stimulus to accept or reject a perspective will depend on the level of initial wealth
used as a point of reference. Thus, for theory, the difference between the new level of wealth and the
previous level used for comparison is what guides the choice between perspectives.
 Human perception depends on the reference used (perceived attributes of a situation will depend
on the context in which it is inserted and the stimuli received by the individual).
•
The decision-making process takes place in two stages:
 Edition: in which perspectives are reorganized and reformulated to make them simpler and easier
to analyze. Thus, through processes such as coding - when possible outcomes are classified as loss
or gain from a point of reference that will depend on the individual's wealth - cancellation - when
prospects whose possible outcomes have equal components are discarded - and others. Complex
situations are edited with the aim of making the decision-making process simpler.
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Prospect Theory
New Explanation for Utilitarian Theory
 Assessment: the perspectives are analyzed and the one with the highest value will be chosen.
Although it facilitates decision-making, the editing phase can lead to changes in preferences since
the next evaluation phase depends on the simplification.
 Using these steps, decision making becomes a simpler process that depends more on mental shortcuts,
emotions, and instincts, and less on careful evaluations of information and analysis of outcome
probabilities (Lehrer, 2010).
 The value of the perspectives after editing, called V, will depend on the weight function of the decision
𝝅
, and on the value given to the result, v( ), which is subjective.
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Prospect Theory
New Explanation for Utilitarian Theory
 In cases where the sum of the probabilities is equal to 1 and x > y > 0 or x < y < 0 the formula used
becomes:
 The difference in the equation to be used in each case is due to the operations performed in the editing
phase.
 Thus, in the last formula, the right component of the results, here v(y), is separated from the rest
of the formula for the evaluation and the weight of the decision is associated with the risk factor,
ie the difference between the values of the results.
 Greater value is attributed to changes in the individual's wealth than to the final state of the
individual. In this way, the value function is defined by variations from the reference point.
 According to the formulas above, the gains and losses, decrease with the magnitude of the results,
which indicates a concave function in the gains and convex in the losses.
 Risk aversion on the earnings side and;
 Propensity for risk on the loss side.
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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The Value Function
• The value function below indicates that people usually feel more displeased with the experience of
losing an amount than the satisfaction provided by earning the same amount.
Propriedades da Função Valor:
• Subaditivit: when the probability value is small, it is
possible to notice that 𝜋 𝑟𝑝 > 𝑟𝜋 𝑝 for 0 < 𝑟 < 1;
The function does not behave well at
extremes because of the understatement
at very small probabilities.
• Excess weight: when the odds are very low, in general,
exaggerated weights are assigned to the decision of
these, ie: 𝜋 𝑝 > 𝑝 for small p’s;
• Subcertainty: the sum of the weights associated with
complementary events is less than the weight
associated with the right event. In this case: 𝜋 𝑝 +
𝜋 1 − 𝑝 < 1para todo 0 < p < 1;
• Subproportionality: for a fixed proportion of
probabilities, the proportion of the corresponding
decision weights is closer to 1 when the probabilities
are low than when they are high.
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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The Value Function
Problem 8:
SITUATION 1: (Problem 13)
A:
N=68
Win $ 6.000
25%
B:
[18%]
Win $ 4.000
Win $ 2.000
25%
25%
[82%]*
SITUATION 2: (Problem 13’)
C:
N=68
Lose $ 6.000
25%
D:
[70%]*
Lose $ 4.000
Lose $ 2.000
100%
[30%]
• Solving the problem above by the proposed model has:
𝝅 𝟎, 𝟐𝟓 𝒗 $𝟔. 𝟎𝟎𝟎 < 𝝅 𝟎, 𝟐𝟓 𝒗 $𝟒. 𝟎𝟎𝟎 + 𝒗 $𝟐. 𝟎𝟎𝟎
𝝅 𝟎, 𝟐𝟓 𝒗 −$𝟔. 𝟎𝟎𝟎 > 𝝅 𝟎, 𝟐𝟓 𝒗 −$𝟒. 𝟎𝟎𝟎 + 𝒗 −$𝟐. 𝟎𝟎𝟎
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Prospect Theory
Conclusions
•
Thus, the decision weight associated with an event will depend primarily on the perceived probability
of that event, and this event may be subject to serious bias. Influencing Factors:
 Vague descriptions;
 Ambiguities
In conclusion, individuals are often risk takers
when dealing with unlikely and risk-averse gains
when dealing with unlikely losses.
Example: lotteries and insurance
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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Prospect Theory
Conclusions
•
Prospect theory distinguishes two stages in the decision-making process:
 Editing phase: is the framing, which consists of a preliminary analysis of the decision problem. It
includes mental operations so that the acts, results and probability are combined, transformed
and reformulated in order to simplify the subsequent evaluation and choice.
 Evaluation phase: the decision maker should evaluate each of the prospects and opt for the one
with the highest expected value.
•
It maintains the structure of the expected utility theory, in the sense that the decision to be made is
the most expected utility (theory replaces the word utility with 'value', although meaning remains the
same) but proposes a value function And another treatment of probabilities, reflected in the function of
decision weights (decision weights).
•
But the probabilities are usually not explicit, as in the examples presented, and therefore they must be
accessed subjectively.
PEOPLE USE HEURISTIC PRINCIPLES IN THE DECISION-MAKING!
Kahneman, D. & Tversky, Amos. “Prospect Theory: An Analysis of Decision under Risk” Econométrica, Vol 47, mar., 1979
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The Endowment Effect, Loss Aversion, and Status Quo Bias
Definition
•
Endowment Effect: Is the inclination that an individual has to value one more item that owns it than the
same item if it is not part of the allocation.
•
Loss Aversion: Is the disutility of giving up an object is greater than the utility associated with acquiring
it.
•
Status Quo Bias: an implication of loss aversion is that individuals have a strong tendency to remain in
the status quo because the disadvantages of leaving it seem larger.
•
These three effects are considered anomalies when analyzed by classical utilitarian theory.
Daniel Kahneman; Jack L. Knetsch; Richard H. Thaler. “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias” Journal of Economic Perspectives, Vol 5, winter, 1999
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The Endowment Effect, Loss Aversion, and Status Quo Bias
Definições
•
Economist Jack Knetsch conducted a famous experiment that evidences the possession effect. In it, half
of the participants received a mug as a reward for participating in the completion of a questionnaire.
After filling, participants were offered the opportunity to swap their mugs for a chocolate bar. The same
was done in the opposite direction for the other half of the candidates, ie they were rewarded with
chocolate bar and was offered to swap for a pint. The percentage of applicants who switched their initial
appropriations was much lower than the percentage of applicants who remained with the same initial
good.
•
Some economists believed that this behavior would disappear if individuals were exposed to a market
environment with ample learning opportunities.
•
Thus the discrepancy between buying and selling prices can be produced by the unthinking
application of normally sensitive trading habits, ie by underestimating the true willingness to pay
(WTP) and exaggerating the minimum acceptable price at which it could be sold (willingness to accept
or WTA).
Daniel Kahneman; Jack L. Knetsch; Richard H. Thaler. “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias” Journal of Economic Perspectives, Vol 5, winter, 1999
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The Endowment Effect, Loss Aversion, and Status Quo Bias
The Endowment Effect
•
Classical microeconomic theory asserts that two indifference curves can never cross, for it would go
against the axiom of transitivity (if A> B and B> C, then A> C, if X ~ Y and Y ~ Z, then X ~ Z ).
•
But the experiments at Cornel University with advanced economics students (63 students) and Simon
Frasier University (77 students) show that indifference curves can intersect, which would be an anomaly
to the transitivity axiom.
Daniel Kahneman; Jack L. Knetsch; Richard H. Thaler. “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias” Journal of Economic Perspectives, Vol 5, winter, 1999
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The Endowment Effect, Loss Aversion, and Status Quo Bias
The Endowment Effect
•
In this case the principle of transitivity has been broken
Δx2
Δx1
TMS=
Δx2/Δx1
x
1
Daniel Kahneman; Jack L. Knetsch; Richard H. Thaler. “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias” Journal of Economic Perspectives, Vol 5, winter, 1999
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The Endowment Effect, Loss Aversion, and Status Quo Bias
Judgments of fairness and justice
•
The implications of these behaviors affect decisions of what would be fairness and justice in contracts and how
to deal with the concept of justice from the utilitarian point of view.
•
Need to revise the Classical Microeconomic Theory in the assumptions of the model.
•
Consumer behavior models should be revised to incorporate these new theories.
Daniel Kahneman; Jack L. Knetsch; Richard H. Thaler. “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias” Journal of Economic Perspectives, Vol 5, winter, 1999
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• Transdisciplinar
- Representa um nível de integração disciplinar além da interdisciplinaridade;
- Etapa superior de integração onde não existe fronteira entre as disciplinas;
- Um sistema de ensino inovado;
- Busca superar o conceito de disciplina.
- É a busca do sentido da vida através de relações entre os diversos saberes (ciências exatas, humanas
e artes) numa democracia cognitiva.
- Nenhum saber é mais importante que outro. Todos são igualmente importantes.
EAD-5808 – Comportamento do Consumidor
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PPGA FEA-USP