Prospect Theory and its Hidden Role
in Thinking about Sunk Costs
Jim Stodder, RPI, Fall 2014
Daniel Kahneman &
(Nobel, 2002)
Amos Tversky
(Died, 1996)
The ‘Flag’ of Prospect Theory
Often Claimed: Shows how “losses are
more important than gains.”
True, but not critical. VNM Expected Utility
Theory shows that too!
Diminishing Marginal Utility
It’s Risk-Aversion vs. Risk-Loving
that Matters!
0.4
Loss-Aversion
6
Psychological Value
Expected Values = -$16, +$16
Gains
4
2
0
-$40 -$36 -$32 -$28 -$24 -$20 -$16 -$12 -$8 -$4
-2
-4
-6
-8
Losses
-10
-12
$0
$4
$8 $12 $16 $20 $24 $28 $32 $36 $40