Decision makers do not have unlimited time to make decisions.
They will inevitably make misjudgments in the evaluation process. They are not capable of judging their information and alternatives perfectly. Decision makers have limited analytical and computational abilities.Decision makers do not have access to all possible information relevant to the decision, and the information they do have is often flawed and imperfect.Three specific limitations are generally enumerated: This concept revolves on a recognition that human knowledge and capabilities are limited and imperfect. In a purely rational approach, the numbers and calculations involved work the same way regardless of whether the situation is one involving potential gain or potential loss.Īnother theory that suggests a modification of pure rationality is known as bounded rationality. One of the common examples of this is that many individuals think differently about the risk of financial loss than they do when considering situations where different levels of financial gain are concerned. However, Daniel Kahneman and Amos Tversky, the developers of prospect theory, demonstrated through various experiments that most people alter that approach based on their subjective judgments in any given situation. Notice the numerical and logical approach to that analysis. Most strictly rational approaches to questions of financial risk rely on the principle of expected value, where the probability of an event is multiplied by the resulting value should the event occur. Ideas that Complement and Contrast with Rational Decision Makingĭaniel Kahneman is one of the developers of prospect theory.Īn epoch-making idea in the field of behavioral economics, prospect theory is a complex analysis of how individuals make decisions when there is risk involved.
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