Chapter summaries and key concepts

¶ … Bernoulli's Errors" because of the link to Swiss scientist Daniel Bernoulli who believed that the psychological value of a gamble is differently measured in our minds than the possible dollar outcomes. It examines the thinking process that goes into deciding upon risky behaviors, between the differences of behavior that work towards a gamble or a "sure thing." It is clear that we, as mere humans and not Econs, are not able to tell the future impacts of any decisions we make. We may think we know, but not in all certainty. This complicates decision making behind simple gambles. The author thus conducted a study on gambling decision making, to see whether or not the general public shared their own preference for the sure thing. They knew that most people disliked risk because of Bernoulli's findings. The concept of prospect theory soon resulted from the study and aimed to make up for some of Bernoulli's errors.

Chapter 26

Here, the authors dive deeper into prospect theory. Essentially, the authors believe that wealth itself has an impact on decision making, not necessarily only changes in wealth. In utility theory, amounts of wealth change dramatically in terms of their value depending on how wealthy the individual actually is. Yet, prospect theory states something quite differently; that "attitudes toward risk would not be different if your net worth were higher or lower by a few thousand dollars" as well as the fact that evaluation of your money does not matter as much as we think in decision making when exposed to a gamble. Prospect theory complicates utility theory by adding the necessity of a reference point. Thus, the evaluation of the decision is partly determined by the reference point in combination with the idea of diminishing sensitivity and loss aversion.

Chapter 27

This chapter examines the "Endowment Effect." The reference points needed for prospect theory tend to be missing in common methodologies of analysis. An indifference curve does not allow such complicated factors to be present in the evaluation. Yet, this is a crucial element of one's decision making, especially when it comes to dealing with financial gambles. The chapter looks at Thaler's endowment effect. Here, we are more inclined to be stronger in our responses to worse aversions, rather than our responses to bigger gains.

Chapter 28