What is more important, the outcome or the probability?

Author： Shavit Tal Rosenboim Mosi Shani Yaniv

ISSN： 1466-4291

Source： Applied Economics Letters, Vol.20, Iss.2, 2013-02, pp. : 127-130

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Abstract

According to basic economic theory, people wish to maximize their expected utility. In order to do so they should integrate the likelihood (i.e. probability) and the possible outcomes (good or bad). Nevertheless, research has shown that people do not always account for their decisions on the basis of a rational or a cold evaluation of utility. We suggest that when choosing between two risky alternatives people determine the relative perceived importance of the outcomes and probabilities before making their choice. If the outcome is more important, they will tend to choose the option with the best outcome. If the probability is more important, they will tend to choose the option with the higher probability for the desirable outcome, or the option with the lower probability for the undesirable outcome. This means that people maximize their utility based on their perceived importance of probabilities and outcomes. To test our argument, we conducted an experiment in which we asked the participants to decide between two uncertain outcomes. The results support our claim that the importance of the probability and the importance of the outcome affect the choice between two risky alternatives.