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38626 results in Cambridge Textbooks

Page 1834 of 1932

  • 19 - Money Illusion

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 335-355

  • Summary

    ABSTRACT. The term money illusion refers to a tendency to think in terms of nominal rather than real monetary values. Money illusion has significant implications for economic theory, yet it implies a lack of rationality that is alien to economists. This paper reviews survey questions, which are designed to shed light on the psychology that underlies money illusion, regarding people's reactions to variations in inflation and prices. We propose that people often think about economic transactions in both nominal and real terms and that money illusion arises from an interaction between these representations, which results in a bias towards a nominal evaluation.

    “A nickel ain't worth a dime anymore.”

    Yogi Berra

    We have standardized every other unit in commerce except the most important and universal unit of all, the unit of purchasing power. What business man would consent for a moment to make a contract in terms of yards of cloth or tons of coal, and leave the size of the yard or the ton to chance? … We have standardized even our new units of electricity, the ohm, the kilowatt, the ampere, and the volt. But the dollar is still left to the chances of gold mining.

    Irving Fisher, 1913

    The term money illusion refers to a tendency to be influenced by nominal as well as real monetary values in one's thinking about, and the conduct of, economic transactions. Money illusion has significant implications for economic theory, yet it implies a lack of rationality that is alien to economists.

  • 20 - Labor Supply of New York City Cab Drivers: One Day at a Time

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 356-370

  • Summary

    “It was raining hard in Frisco/I needed one more fare to make my night”

    Harry Chapin, “Taxi”

    INTRODUCTION

    Theories of labor supply predict how the number of hours people work will change when their hourly wage or income changes. The standard economic prediction is that a temporary increase in wages should cause people to work longer hours. This prediction is based on the assumption that workers substitute labor and leisure intertemporally, working more when wages are high and consuming more leisure when its price - the forgone wage - is low (e.g., Lucas and Rapping 1969). This straightforward prediction has proven difficult to verify. Studies of many types often find little evidence of intertemporal substitution (e.g., Laisney, Pohlmeier, and Staat 1996). However, the studies are ambiguous because when wages change, the changes are usually not clearly temporary (as the theory requires). The studies also test intertemporal substitution jointly along with auxiliary assumptions about persistence of wage shocks, formation of wage expectations, separability of utility in different time periods, and so forth.

    An ideal test of labor supply responses to temporary wage increases requires a setting in which wages are relatively constant within a day but uncorrelated across days, and hours vary every day. In such a situation, all dynamic optimization models predict a positive relationship between wages and hours (e.g., MaCurdy, 1981, p. 1074).

  • 26 - Conflict Resolution: A Cognitive Perspective

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 473-488

  • Summary

    Many different disciplines deal with the resolution of conflict. Even within the single discipline of psychology, conflict can be approached from different perspectives. For example, there is an emotional aspect to interpersonal conflict, and a comprehensive psychological treatment of conflict should address the role of resentment, anger, and revenge. In addition, conflict resolution and negotiation are processes that generally extend over time, and no treatment that ignores their dynamics can be complete. In this chapter we do not attempt to develop, or even sketch, a comprehensive psychological analysis of conflict resolution. Instead, we explore some implications for conflict resolution of a particular cognitive analysis of individual decision making. We focus on three relevant phenomena: optimistic overconfidence, the certainty effect, and loss aversion. Optimistic overconfidence refers to the common tendency of people to overestimate their ability to predict and control future outcomes; the certainty effect refers to the common tendency to overweight outcomes that are certain relative to outcomes that are merely probable; and loss aversion refers to the asymmetry in the evaluation of positive and negative outcomes, in which losses loom larger than the corresponding gains. We shall illustrate these phenomena, which were observed in studies of individual judgment and choice, and discuss how these biases could hinder successful negotiation. The present discussion complements the treatment offered by Neale and Bazerman (1991).

  • 13 - Framing, Probability Distortions, and Insurance Decisions

  • from PART FOUR - FRAMING AND MENTAL ACCOUNTING
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 224-240

  • Summary

    ABSTRACT. A series of studies examines whether certain biases in probability assessments and perceptions of loss, previously found in experimental studies, affect consumers' decisions about insurance. Framing manipulations lead the consumers studied here to make hypothetical insurance-purchase choices that violate basic laws of probability and value. Subjects exhibit distortions in their perception of risk and framing effects in evaluating premiums and benefits. Illustrations from insurance markets suggest that the same effects occur when consumers make actual insurance purchases.

    KEY WORDS insurance decisions, biases, probability distortions, framing

    Insurance purchases form the basis for an extraordinarily large industry. The industry has assets of $1.6 trillion and employs over 2 million people (Insurance Information Institute, 1990a). Consumers are responsible for a significant proportion of this market, either directly through their own purchase decisions, or indirectly through their choices of employers, mortgages, etc. These investments are sizable and commonplace. For example, the average insured household carries over $100,000 of life insurance, and surveys reveal that 70% of all households report having property insurance. Insurance represents, perhaps, the most significant tool for managing financial risks available to individuals.

    The last decade has seen the advent of an “insurance crisis” in the U.S. and several other countries. With respect to liability insurance, for example, there have been large increases in premiums and vanishing coverage for some risks, factors that present major problems for businesses, professionals, and consumers (Committee for Economic Development, 1989).

  • 32 - Preferences for Sequences of Outcomes

  • from PART SEVEN - CHOICE OVER TIME
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 565-577

  • Summary

    ABSTRACT. Existing models of intertemporal choice normally assume that people are impatient, preferring valuable outcomes sooner rather than later, and that preferences satisfy the formal condition of independence, or separability, which states that the value of a sequence of outcomes equals the sum of the values of its component parts. The authors present empirical results that show both of these assumptions to be false when choices are framed as being between explicitly defined sequences of outcomes. Without a proper sequential context, people may discount isolated outcomes in the conventional manner, but when the sequence context is highlighted, they claim to prefer utility levels that improve over time. The observed violations of additive separability follow, at least in part, from a desire to spread good outcomes evenly over time.

    Decisions of importance have delayed consequences. The choice of education, work, spending and saving, exercise, diet, as well as the timing of life events, such as schooling, marriage, and childbearing, all produce costs and benefits that endure over time. Therefore, it is not surprising that the problem of choosing between temporally distributed outcomes has attracted attention in a variety of disciplinary settings, including behavioral psychology, social psychology, decision theory, and economics.

    In spite of this disciplinary diversity, empirical research on intertemporal choice has traditionally had a narrow focus. Until a few years ago, virtually all studies of intertemporal choice were concerned with how people evaluate simple prospects consisting of a single outcome obtained at a point in time. The goal was to estimate equations that express the basic relationship between the atemporal value of an outcome and its value when delayed.

  • 23 - Overconfidence and Excess Entry: An Experimental Approach

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 414-423

  • Summary

    INTRODUCTION

    Psychological studies demonstrate that most individuals are overconfident about their own abilities, compared with others, as well as unreasonably optimistic about their futures (e.g., Taylor and Brown 1988, Weinstein 1980). When assessing their position in a distribution of peers on almost any positive trait such as driving ability or income prospects, 90% of people say they are in the top half (see Svenson 1981). Few people say they are below average, although half must be.1

    This paper explores one setting in which optimistic biases could plausibly and predictably influence economic behavior: entry into competitive games or markets. Many empirical studies show that most new businesses fail within a few years. For example, using plant level data from the U.S. Census of Manufacturers spanning 1963-1982, Dunne, Roberts, and Samuelson (1988) estimated that 61.5% of all entrants exited within 5 years and 79.6% exited within 10 years. Most of these exits are failures (see also Dunne, Roberts, and Samuelson 1988, 1989a, Shapiro and Khemani 1987).

    There are many possible explanations for the high rate of business failure (reviewed below). In this paper we consider the hypothesis that business failure is a result of managers acting on the optimism about relative skill they exhibit in surveys.

  • Preface

  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp ix-xviii

  • Summary

    This preface is not the one that Amos Tversky and I intended to write. Soon after Amos learned early in 1996 that he only had a few months to live, we decided to edit a joint book on decision making that would collect much of our work on this topic and congenial research by others. The collection was to be a sequel and companion to a volume on heuristics and biases of judgment that we had edited together with Paul Slovic many years earlier, and a substitute for a book that Amos and I had promised the Russell Sage Foundation.

    Most of the editorial task was completed quickly, although some new pieces that Amos wanted to include - notably one that I was to write - were only completed long after he was gone. The problem of writing a preface was more difficult than finding articles we liked. Our initial aspirations for the preface were high; we were going to write a broad essay presenting a view of how the field had changed in the preceding 20 years. But we ran out of time before we had a presentable product. Amos advised me to “trust the model of me that is in your mind” and write for both of us. This was not advice that I was able to follow: the risk of writing in his name statements that he might have rejected proved intimidating to the point of paralysis.

  • 12 - Rational Choice and the Framing of Decisions

  • from PART FOUR - FRAMING AND MENTAL ACCOUNTING
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 209-223

  • Summary

    ABSTRACT. Alternative descriptions of a decision problem often give rise to different preferences, contrary to the principle of invariance that underlies the rational theory of choice. Violations of this theory are traced to the rules that govern the framing of decision and to the psychophysical principles of evaluation embodied in prospect theory. Invariance and dominance are obeyed when their application is transparent and often violated in other situations. Because these rules are normatively essential but descriptively invalid, no theory of choice can be both normatively adequate and descriptively accurate.

    The modern theory of decision making under risk emerged from a logical analysis of games of chance rather than from a psychological analysis of risk and value. The theory was conceived as a normative model of an idealized decision maker, not as a description of the behavior of real people. In Schumpeter's words, it “has a much better claim to being called a logic of choice than a psychology of value” (1954, p. 1058).

    The use of a normative analysis to predict and explain actual behavior is defended by several arguments. First, people are generally thought to be effective in pursuing their goals, particularly when they have incentives and opportunities to learn from experience. It seems reasonable, then, to describe choice as a maximization process. Second, competition favors rational individuals and organizations. Optimal decisions increase the chances of survival in a competitive environment, and a minority of rational individuals can sometimes impose rationality on the whole market.

  • 10 - A Test of the Theory of Reference-Dependent Preferences

  • from PART THREE - LOSS AVERSION AND THE VALUE FUNCTION
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 180-201

  • Summary

    ABSTRACT. Eight alternative methods of eliciting preferences between money and a consumption good are identified: two of these are standard willingness-to-accept and willingness-to-pay measures. These methods differ with respect to the reference point used and the dimension in which responses are expressed. The loss aversion hypothesis of Tversky and Kahneman's theory of reference-dependent preferences predicts systematic differences between the preferences elicited by these methods. These predictions are tested by eliciting individuals' preferences for two private consumption goods; the experimental design is incentive-compatible and controls for income and substitution effects. The theory's predictions are broadly confirmed.

    In conventional consumer theory each individual's choices are determined by a preference ordering over consumption bundles; this ordering is independent of the individual's endowment. However, a number of recent papers have suggested that preferences may be conditioned on current endowments, and that individuals are typically “loss averse”: for example, a person may prefer bundle x to bundle y if she is endowed with x, but prefer y to x if endowed with y. The most fully worked-out general theory of this kind is probably Tversky and Kahneman's [1991] theory of reference-dependent preferences. Tversky and Kahneman present their theory as an explanation of a body of preexisting evidence. In this paper we report a systematic experimental test of some of the implications of reference-dependent theory.

  • 38 - Evaluation by Moments: Past and Future

  • from PART NINE - EXPERIENCED UTILITY AND OBJECTIVE HAPPINESS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 693-708

  • Summary

    We often have the occasion to evaluate the pleasantness or awfulness of incidents in people's lives; most of us have opinions about what it is like to be old, or physically handicapped, or a resident of California. All of us spontaneously score events and situations and store evaluations of how good or bad they were, in the form of likes and dislikes. These judgments and feelings have also been produced in the laboratory, with the usual combination of artificiality and improved precision.

    The goal of this chapter is to review the evidence for a unifying principle, which accounts for four conclusions of research on evaluations of outcomes. The first of these conclusions has been supported in many studies of choice.

  • The carriers of value in both risky and riskless choices are gains and losses. The same final state of wealth or endowment is valued differently, depending on its relation to the original state from which it has been reached (Kahneman and Tversky 1979). In studies of the endowment effect, for example, the outcomes of owning or not owning a particular decorated mug are represented, depending on the current reference point, as getting a mug or giving up a mug (Kahneman, Knetsch, and Thaler 1991; Thaler 1980; Tverksy and Kahneman 1991).

  • 27 - The Construction of Preference

  • from PART SIX - THE MULTIPLICITY OF VALUE: REVERSALS OF PREFERENCE
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 489-502

  • Summary

    ABSTRACT. One of the main themes that has emerged from behavioral decision research during the past 2 decades is the view that people's preferences are often constructed in the process of elicitation. This concept is derived in part from studies demonstrating that normatively equivalent methods of elicitation often give rise to systematically different responses. These “preference reversals” violate the principle of procedure invariance that is fundamental to theories of rational choice and raise difficult questions about the nature of human values. If different elicitation procedures produce different orderings of options, how can preferences be defined and in what sense do they exist? Describing and explaining such failures of invariance will require choice models of far greater complexity than the traditional models.

    The meaning of preference and the status of value may be illuminated by this well-known exchange among three baseball umpires. “I call them as I see them,” said the first. “I call them as they are,” claimed the second. The third disagreed, “They ain't nothing till I call them.” Analogously, we can describe three different views regarding the nature of values. First, values exist - like body temperature - and people perceive and report them as best they can, possibly with bias (“I call them as I see them”). Second, people know their values and preferences directly - as they know the multiplication table (“I call them as they are”). Third, values or preferences are commonly constructed in the process of elicitation (“They ain't nothing till I call them”). The research reviewed in this article is most compatible with the third view of preference as a constructive, context-dependent process.

    (Tversky & Thaler, 1990, p. 210)

  • 37 - Experienced Utility and Objective Happiness: A Moment-Based Approach

  • from PART NINE - EXPERIENCED UTILITY AND OBJECTIVE HAPPINESS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 673-692

  • Summary

    INTRODUCTION

    The concept of utility has carried two different meanings in its long history. As Bentham (1789) used it, utility refers to the experiences of pleasure and pain, the “sovereign masters” that “point out what we ought to do, as well as determine what we shall do.” In modern decision research, however, the utility of outcomes refers to their weight in decisions: utility is inferred from observed choices and is in turn used to explain choices. To distinguish the two notions I refer to Bentham's concept as experienced utility and to the modern usage as decision utility. Experienced utility is the focus of this chapter. Contrary to the behaviorist position that led to the abandonment of Bentham's notion (Loewenstein 1992), the claim made here is that experienced utility can be usefully measured.

    The chapter has three main goals: (1) to present a detailed analysis of the concept of experienced utility and of the relation between the pleasure and pain of moments and the utility of more extended episodes; (2) to argue that experienced utility is best measured by moment-based methods that assess current experience; (3) to develop a moment-based conception of an aspect of well-being that I will call “objective happiness.” The chapter also introduces several unfamiliar concepts that will be used in later chapters.

    Pleasure and pain are attributes of a moment of experience, but the outcomes that people value extend over time. It is therefore necessary to establish a concept of experienced utility that applies to temporally extended outcomes. Two approaches to this task will be compared here.

  • 15 - Toward a Positive Theory of Consumer Choice

  • from PART FIVE - APPLICATIONS
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 269-287

  • Summary

    ABSTRACT. The economic theory of the consumer is a combination of positive and normative theories. Since it is based on a rational maximizing model it describes how consumers should choose, but it is alleged to also describe how they do choose. This paper argues that in certain well-defined situations many consumers act in a manner that is inconsistent with economic theory. In these situations economic theory will make systematic errors in predicting behavior. Kahneman and Tversky's prospect theory is proposed as the basis for an alternative descriptive theory. Topics discussed are under-weighting of opportunity costs, failure to ignore sunk costs, search behavior, choosing not to choose and regret, and precommitment and self-control.

    INTRODUCTION

    Economists rarely draw the distinction between normative models of consumer choice and descriptive or positive models. Although the theory is normatively based (it describes what rational consumers should do), economists argue that it also serves well as a descriptive theory (it predicts what consumers in fact do). This paper argues that exclusive reliance on the normative theory leads economists to make systematic, predictable errors in describing or forecasting consumer choices.

    In some situations the normative and positive theories coincide. If a consumer must add two (small) numbers together as part of a decision process, then one would hope that the normative answer would be a good predictor. So if a problem is sufficiently simple the normative theory will be acceptable. Furthermore, the sign of the substitution effect, the most important prediction in economics, has been shown to be negative even if consumers choose at random (Becker, 1962).

  • 7 - Loss Aversion in Riskless Choice: A Reference-Dependent Model

  • from PART THREE - LOSS AVERSION AND THE VALUE FUNCTION
  • Edited by Daniel Kahneman, Princeton University, New Jersey, Amos Tversky, Stanford University, California
  • Book:
    Choices, Values, and Frames
    Published online:
    01 February 2019
    Print publication:
    25 September 2000, pp 143-158

  • Summary

    ABSTRACT. Much experimental evidence indicates that choice depends on the status quo or reference level: changes of reference point often lead to reversals of preference. We present a reference-dependent theory of consumer choice, which explains such effects by a deformation of indifference curves about the reference point. The central assumption of the theory is that losses and disadvantages have greater impact on preferences than gains and advantages. Implications of loss aversion for economic behavior are considered.

    The standard models of decision making assume that preferences do not depend on current assets. This assumption greatly simplifies the analysis of individual choice and the prediction of trades: indifference curves are drawn without reference to current holdings, and the Coase theorem asserts that, except for transaction costs, initial entitlements do not affect final allocations. The facts of the matter are more complex. There is substantial evidence that initial entitlements do matter and that the rate of exchange between goods can be quite different depending on which is acquired and which is given up, even in the absence of transaction costs or income effects. In accord with a psychological analysis of value, reference levels play a large role in determining preferences. In the present paper we review the evidence for this proposition and offer a theory that generalizes the standard model by introducing a reference state.

Page 1834 of 1932