Comments on Kahneman and Tversky The article “Prospect Theory: An Analysis of Decision Under Risk” by Daniel Kahneman and Amos Tversky presents a critique of expected utility theory as a descriptive model of decision making under risk and develops an alternative model, called perspective theory. In their explanation, there are two ways in which prospect theory differs from expected utility theory. First, while utility is linear, value is not. Second, while utility depends on final wealth, value is defined in terms of gains and losses. Therefore, below, we examine how prospect theory explains three effects that people use when making decisions. The first effect is called the certainty effect, which illustrates the dependence of subjects' choices on whether the options are framed as a gain or a loss. People prefer certain options over those that have the possibility of winning more but also risk getting nothing. Say no to plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get an Original Essay For example, when offered a choice between getting $1000 for certain or having a 50% chance of getting $2500, participants will choose the $1000 certain in preference to the uncertain chance of getting $2500, however when faces a certain loss of $1000 versus a 50% chance of no loss or a loss of $2500 often chooses the risky alternative. Therefore, when facing certain losses, people adopt risk-seeking behavior to avoid a larger loss and are risk averse to gains. The second effect is the isolation effect, which refers to the tendency of people to ignore the elements shared by the alternatives and to focus on the components that distinguish them. Discarding common elements reduces the burden of comparing alternatives, but preferences can also be altered by different representations of probabilities. Then, Daniel Kahneman and Amos Tversky present participants with 2 scenarios. In both cases, subjects are given an initial sum of money, and then must choose between two alternatives. (Problem 11 and 12) Although the initial amounts are different in the two cases, it turns out that the two situations are equivalent. However, participants made opposite choices in the two cases, the majority choosing risk-averse option B in scenario 1 and loss-averse option C in scenario 2. The last effect introduced is loss aversion. A significant finding of Kahneman and Tversky's work is that people's attitudes toward risks related to gains can be very different from their attitudes toward risks related to losses. Most people will behave in such a way that they are able to avoid losses because people's reaction to loss is more extreme than their reaction to gain, even if the probability of obtaining such losses is minimal. The pain of loss also explains why, when gambling, winning $100 and then losing $80 feels like a net loss even though you're actually ahead by $20. Bottom line, people normally perceive outcomes as gains and losses , rather than as end states of wealth or well-being. By examining the certainty effect, the isolation effect, and loss aversion, Kahneman and Tversky understand that people's behavior is risk-taking for losses and risk-averse behavior for gains. According to prospect theory, value is assigned to gains and losses rather than final assets, and probabilities are replaced by decision weights. Therefore,.