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# System prepended metadata

title: Prospect Theory

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# 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
![](https://i.imgur.com/WJCLO7x.png)
![](https://i.imgur.com/uk7Fcj4.png)
