# Prospect Theory
## Expected utility theory
- Three important concepts
- Utility (psycological value)
- Wealth (current state)
- Rational choice model
- Utility
- Utility does not increase proportionalately with the amount of money
- A gamble should be assessed by its expected utility, not by expected absolute value
- Wealth
- Utility is dependent on the current state of wealth
- Wealth is included when calculated best option
- Model of rational choice
- The utility of potential outcomes is weighted by the probability of its occurrence
- People are expected to select the best option
- Issues with expected utility theory
- People often don't make decisions based on rational cost-benefit analyses:
- People have an irrational tendency to be less willing to gamble with profits than with losses => **prospect theory**
- We use mental shortcuts insteal of calculating all possible option => **heuristics**

## Prospect theory
- People don't always make rational decisions because they value **gains** and **losses** differently