Question

Compare and contrast expected utility theory with prospect theory by stating at least 3 aspects

Answer 1

In Expected Utility theory the choices are made by weighting outcome of actions by probabilities. This theory is based on three tenets; consistency of preference for alternatives, linearity in assigning of weights given to decisions, judgement to fixed assets. On the other hand, prospect theory proves empirical evidences from different classes of choice problems which violate the axioms of expected utility theory. There is two stage processes in the prospect theory. Editing of alternatives in first stage. The edited alternatives evaluated in the second phase. Expected theory focus on the decisions of model and prospect theory describes the actual behaviour of the people.
Three aspects:
Choices are adjustment from personal reference point. Most of the people were risk averse towards adjustment.
Decision makers tend to give overweight unlike events and underweight likely events.
The selected alternatives can influence the choices.