Human Behavior and Decision-Making Through Prospect Theory

Introduction to Prospect Theory

Human beings base their everyday decisions and actions upon a very specific assessment of risk and reward. When offered a choice, people naturally begin to narrow down the potential outcomes of any decision relative to those choices, usually using some sort of weighted scale or process to help determine which decision or set of actions will lead to the most favorable outcome. When outcomes are less predictable, or when large amounts of risk are involved, human beings employ much more complicated thought and reasoning processes to make and act upon their decisions.

These situations — where the complexity of reality and the decisions to be made are heightened — represent very good real-life examples of the problems humans face each day. Certain decision-making scenarios, where the potential for limitless possibilities and outcomes exists, are much harder to navigate. These decisions and scenarios are governed by what theorists have deemed Prospect Theory. This theory takes into account the fact that humans often perform complex risk-and-reward assessments when making decisions, but that each decision is not created equal, and the complexities of the real world certainly present the decision-maker with interesting and often limitless possibilities.

Key Concepts and Theoretical Foundations

The original developers of Prospect Theory, Daniel Kahneman and Amos Tversky, began to compartmentalize the world of decisions and risk assessment into several key considerations. These key elements help break down natural thought and risk-assessment patterns into a much less complex and more understandable format. Central to these elements is the recognition that human beings often have difficulty imagining the sheer number of possibilities or potential outcomes. This difficulty stems from the way most people live and make decisions in less complex everyday situations. As the complexity of a decision increases and familiarity with the decision or its outcomes decreases, the decision-maker is often left without the benefit of experience or the ability to see and understand all potential outcomes (Tversky and Kahneman, 299).

This concept is also referred to as the "certainty effect," whereby human beings begin a sometimes-complex risk assessment as they ponder the potential outcomes of a decision. Interestingly, when faced with a scenario in which a sure loss is more likely, people tend to be more prone to risk-taking and an "all or nothing" attitude (Tversky and Kahneman, 302). Researchers Markman and Medin, as well as Holyoak, each present individual hypotheses relative to this sort of behavior in their writings, drawing on real-life experiments with controls and a limited set of variables.

These experiments involve real-life decisions and human behavior — specifically gambling. They contain a set number of variations and variables, just as with any game of chance, and the choices studied within these experiments are based upon a certain series of factors. Since Prospect Theory is itself quite complex, containing many sub-theories, it is important to distinguish between the theory itself and the way people assign value to certain outcomes and the successful aversion of risk (Markman and Medin, 414). This assignment of value is based on the notion that human beings assess specific risks individually and evaluate the potential for gains or losses on a much more sporadic scale (Holyoak, 277). This is not to say that humans are unconcerned with the aggregate result of a decision or series of decisions, but rather that this cumulative result is often not the final or ultimate consideration when facing a risky or difficult choice.

Real-World Application: Water Usage and Survival

Many of the most important decisions humans make over the course of their lives involve splitting several potential outcomes or risks into separate categories or possibilities (Holyoak, 278). These possibilities have a great deal to do with the calculation of probabilities, whether known or unknown to the person facing the decision. Designating a low-probability outcome as an option of high weight directly contributes to the appeal of risk-taking and gambling with choices (Holyoak, 280). Holyoak offers several instances in which this claim can be supported.

One of the best examples of Prospect Theory in the everyday lives of humans involves water usage relative to overall human health and well-being. From an economic standpoint, water has no real substitutes; it is an extremely valuable, life-sustaining resource — perhaps the most valuable on the planet. Yet the way water usage is regulated, used, and polluted has become an increasingly contentious subject as humans recognize the importance of this substance. Since the outcomes of disputes and regulations over water resource management are of utmost importance to any government or group of people genuinely concerned with sustainability and survival within a closed water system, it is easy to understand why regulating bodies would want a firm grasp on how human beings make decisions based on risk assessment relative to water consumption.

Whether for good or ill, human psychology plays a rather large role in the allocation and regulation of the planet's water supply. Humans have the potential to sustain themselves or to completely undermine their own survival, based solely on how well equipped they are to handle complex decision-making. Going even more deeply into the human psyche, Prospect Theory clearly illustrates that at the most basic level, humans are afraid of death and dying (Markman and Medin, 415). The aversion of this risk — death — often plays a large role in how decisions are framed and ultimately made. This is just one example of how Prospect Theory is relevant to the human condition, but it is perhaps the most dire example as well.

Conclusion

Prospect Theory goes a long way in describing how human beings make decisions based on risk assessment and outcomes. Human beings are guided by their own psychological limitations and needs, but a basic understanding of this theory points to the fact that all humans — in one way or another — use risk assessment and the potential for certain outcomes to influence their decisions and actions in everyday life. From mundane issues to matters involving the survival of humankind itself, Prospect Theory helps people analyze the way they analyze the world, ultimately leading to a much better understanding of the potential risks and outcomes they face.