Economics Prospect Theory Questions Medium
Framing in Prospect Theory refers to the way in which choices or decisions are presented or framed, which can significantly influence decision-making. According to Prospect Theory, individuals do not make decisions based on absolute values or outcomes, but rather on the way those outcomes are framed or presented to them.
The impact of framing on decision-making can be explained through two main concepts: the framing effect and the reference point.
The framing effect suggests that individuals tend to make different choices depending on how the options are framed. For example, if a decision is presented as a potential gain, individuals are more likely to choose a safer option to avoid losses. On the other hand, if the decision is framed as a potential loss, individuals are more likely to take risks to avoid the loss. This demonstrates that people are risk-averse when it comes to gains but become risk-seeking when it comes to losses.
The reference point is another important aspect of framing. It refers to the starting point or the reference against which individuals evaluate potential gains or losses. Prospect Theory suggests that individuals tend to evaluate outcomes relative to this reference point rather than in absolute terms. For example, if someone starts with $100 and gains an additional $50, they may perceive it as a gain. However, if they start with $200 and lose $50, they may perceive it as a loss. This shows that individuals are more sensitive to losses than gains and are willing to take risks to avoid losses.
Overall, framing in Prospect Theory highlights the significance of how choices are presented and how individuals perceive and evaluate potential gains and losses. It demonstrates that decision-making is not solely based on rational calculations but is influenced by the way options are framed, leading to different choices and behaviors.