Framing and Decision Making

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Session 12

• Framing and Decision Making

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Asian Disease Problem

• Imagine that the US is preparing for the outbreak
  of an unusual Asian disease, which is expected to
  kill 600 people.  Two alternative programs to
  combat the disease have been proposed.  Assume
  that the exact scientific estimates of the
  consequences of the programs are as follows.

• Program A  If Program A is adopted, 200 people
  will be saved.
• Program B  If Program B is adopted, there is 1/3
  probability that 600 people will be saved, and
  2/3 probability that no people will be saved.
• Which of the two programs would you favor?

Program A  If Program A is adopted, 400 people
will die. Program B  If Program B is adopted,
there is 1/3 probability that 1/3 probability
that nobody will die, and 2/3 probability that
600 people will die. Which of the two programs
would you favor?
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Ticket versus Lottery

• Ticket
• 100 for traffic ticket and be done with it, or
  challenge it, and take a 50-50 chance of getting
  it dismissed or paying double the ticket value
  (for court fee).
• Lottery
• Two stage game in which, at end of Stage 1, you
  have won 100. Now you choice is to take your
  cash and leave or go to Stage 2, taking a 50-50
  chance of making an additional 100 or losing
  100.

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Framing and Risk Preference

• Tendency to choose riskier options under loss
  frames rather than gain frames.
• A pure framing effect (Asian Disease Problem)
• A genuine reflection effect (Ticket/Lottery)
• Has to do with shape and curvature of the utility
  functions in the domain of losses and gains.
• This is described in Prospect Theory (Kahneman
  and Tversky, 1979).
• Violates the general assumption of economic
  behavior that people should respond to absolute
  outcomes not relative outcomes.

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Prospect Theory

• Over weighting of certain outcomes
• Certain losses are more aversive, certain gains
  are more attractive.
• Value-function
• Concave in gains
• Convex and steeper in losses
• Decreasing marginal utility and disutility
• The psychological intensity of outcomes of
  increasing magnitude is progressively smaller.

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Prospect Theory and Reflection Effect
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Why then?

• Do people buy lotteries?
• Do people buy insurance?
• Limitations of Prospect Theory
• Holds better in low involvement decisions
• Holds better when outcomes are amenable to
  mathematical computation

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S-P/A Theory

• Security-Potential
• Security orientation leads to risk aversion
• Potential orientation leads to risk seeking
• A personality trait
• Aspiration Level
• The minimum payoff/maximum loss rules the risky
  option in or out
• No clear predictions under losses and gains

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Wheres the Fat?

• Package A states that product contains 75 fat.
• Package B states that product is 25 fat free.
• Which would be preferred more?

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Attribute Framing

• Varying the description of the option by framing
  the attribute of the option.
• Specifically, focusing on presence of undesirable
  versus desirable attributes, or absence of
  desirable versus undesirable attributes.
• Positive attribute framing results in higher
  persuasion compared to negative attribute
  framing.
• Works by trigger differential elaboration.
• Positive frames cause contemplation of positive
  states of affairs relative to negative frames.

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Skin Exam

• By taking the skin exam now, you will give
  yourself an opportunity to detect and treat any
  problems.
• Positive goal frame or outcome frame
• By not taking the skin exam now, you give up an
  opportunity to detect and treat any problems.
• Negative goal or outcome frame.

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Loss Aversion Explanation for Goal Framing Effects

• Everything else being equal, people are more
  averse to losing than they are attracted toward
  gains of equal magnitude.
• Hence, greater motivation to avoid losses.

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Choosing versus Rejecting

• What if we asked people to add options to a base
  computer versus remove options from a fully
  loaded computer.
• Principle of task invariance suggests, nothing
  should change.
• People should wind up with very identical final
  configurations.
• Study
• Simulated computer purchase scenario.
• Online study
• Subjects randomly assigned to choose/reject task

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Effect on Size of Final Option Set

• Rejecting (paring down) results in a
  significantly larger option set compared to
  choosing (building up).
• Y-axis Number of options.

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Effect on Value of Choice Set

• Rejecting results in significantly higher value
  of final option set than choosing.
• Y-axis dollar value of the options in final
  set.

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Biases in Decision Making
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Enhance Production Capacity?

• 9 months back your team decided to go ahead with
  major modification to your production facilities.
• The budget was 10m.
• The project is on time, and scheduled to be
  completed next month.
• The project is on budget, and you have invested
  9m to date.
• You are now informed that a major shift in the
  market place will put your product on a downward
  path to extinction, and there is nothing you can
  do about it.
• The question before you is, should you invest the
  remaining 1m and complete the planned plant
  modification, and continue or should you abandon?
  

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Results

• A significant majority said, invest.
• You are not alone.
• Many examples
• Vietnam
• Concorde
• Hubble
• And this is called, sunk cost fallacy.
• Why does this happen?

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The Source of Sunk Cost Fallacy

• This is a prospect theory account
• Incremental losses look smaller in comparison
  with the potential gain.
• As you invest more, it looks like a bigger waste
  if you abandon, and incremental investment looks
  miniscule in comparison with the increasingly
  remote gain.
• The killer is that the decision-maker starts
  abandoning the probability that modifies the gain.

Investment at T1
Investment at T2
Investment at T3
Investment at T4

• A cost is sunk if it is irretrievable, and has no
  effects on future payoffs.

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Alternate Explanation for Sunk Cost Fallacy

• Cognitive Dissonance
• What is it?
• Tendency to engage in revisionist history while
  looking back at decision.
• Engage in behavior, especially information search
  that
• Strengthens the reasons in favor of decision
• Weakens reasons against.

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More on Sunk Cost Fallacy

• Reverse of Hindsight Bias?
• Also known as irrational escalation of
  commitment.
• Many anecdotes, somewhat weak evidence.
• Bought two tickets for Shows A and B worth 50
  and 100, and prefers Show A, but finds out that
  they are for the same day/time, and people choose
  to go to Show B.
• Shuttle mission justified on investments and
  lives lost.

Source Friedman et al (2003), preliminary
version of manuscript
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Trading Scenario

• Let us say, a slightly intoxicated fellow with
  plenty of money shows up in class and says I am
  feel like giving stuff away.
• I tell him, do the following
• Give half of this class 2.00
• Give the other half, a lottery ticket worth some
  unspecified amount
• Randomly decide who belongs in which half.
• He does just that.
• But then, the Donor thinks a bit and says, Hey
  this is good only for those whose preferences for
  the lottery/money matches what they gotwhat if
  they dont like what they got?
• To which, I say, Okay, give them an opportunity
  to switch to the other gift.
• What do you think happened?

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Endowment Effect

• Mere possession of an object causes it to be over
  valued.
• Result, very few people traded.
• Replicated in trades involving coffee mugs for
  6.00.
• Replicated in trades involving coffee mugs for
  chocolate, 89 and 90 respectively chose to
  retain what was given to them.
• People are willing to pay less than what they
  would expect others to pay.
• Cannot be attributed to a simple economic market
  rationality.
• The dropping of the atomic bomb was justified by
  the 2b spent on the Manhattan Project.

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Indifference Curves
Trade down Attribute A
Desirable Attribute A
Trade down Attribute B
Desirable Attribute B

• Indifferences curves represent the points in
  satisfaction space that are equivalent for two
  combinations of items/attributes of value.
• For example, a person might have in indifference
  curve between engine power and upholstery.
• Equally satisfied with a car with a powerful
  engine with cloth interior as with a care with a
  less powerful engine but a leather interior.
• Indifference curves are not supposed to
  intersect, regardless of whether you start with
  high interiors and trade down to get more power,
  or start with high power and trade down to get a
  better interior.

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More on Endowment Effect

• Endowment effect occurs because indifference
  curves intersect.
• It affects inexperienced traders more than it
  does experienced traders.
• As experience accumulates and trading intensity
  picks up, endowment effects gives way.
• Can be thought of as behavioral inertia.