The psychological insights that won a Nobel Prize in Economics

A Nobel Prize in Economics was given to the psychologist Daniel Kahneman for his joint research with the late psychologist Amos Tversky on decision making under uncertainty and on subjective judgments of uncertainty. The two proposed Prospect Theory as a descriptive alternative to Utility Theory, the reigning normative theory of choice under uncertainty. Kahneman and Tversky argued that human psychology prevents people from being rational in the sense required by Utility Theory -- consistency -- for two main reasons. First, people are more sensitive to changes in position (economic or otherwise) than to final positions, a fact ignored by Utility Theory. Thus, they value a 50% discount on a 100NIS item more than a 5% discount on a 1000 NIS item. Moreover, they are more sensitive to changes for the worse than to changes for the better. Second, we are sensitive not just to outcomes, but to outcomes-under-a-description, which makes us inconsistent from a consequentialist veiwpoint (e.g., we don't feel the same about losing 100 NIS on our way to the theater boxoffice, vs. losing a 100 NIS ticket on our way to the theater). The article describes some of the empirical observations that led to the development of Prospect Theory, and some of its basic tenets.