Reference no: EM132350993
Psychologists have made important contributions to economic theory during the past 40 years, and one of the most influential concepts is known as prospect theory. One implication of prospect theory is that people assign more weight to monetary losses than to equal monetary gains. For example, suppose I flip a fair coin that has equal probability of showing heads or tails, and you gain $100 for a head and lose $100 for a tail. The tools presented imply that the expected outcome of the coin flip is $0, so we should not be willing to pay any amount of money to avoid facing the coin flip. However, many people will pay to avoid the risk associated with the coin flip because they view the possible $100 loss as more important than the possible $100 gain (even though the probabilities are equal).
For practical purposes, prospect theory helps to explain why people take extra steps to avoid losses, even if they are quite unlikely. For example, air travel is now safer than many other forms of long-distance travel, but some people do not fly due to the possibility of a crash even though this outcome has a very low probability of occurrence. People also take extraordinary steps to avoid the outcomes of very rare events like hurricanes, fatal illness, and stock market crashes.
In general, do you agree that some people behave in ways that are compatible with this implication of prospect theory? In particular, do you view losses as more important than equally sized gains? If so, are there particular types of losses that you take extra steps to avoid?
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