What is more important, the outcome or the probability?

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.

Keywords:

• probability
• outcome
• importance
• risk

JEL Classification:

• C91
• D81

Notes

¹ Both expected utility theory (Von Neumann and Morgensten, 1944) and prospect theory (Kahneman and Tversky, 1979) assume that probabilities and outcomes are independent. Thus, these theories do not relate the subjective probability (weighted probability) of the outcome.

² See Lopes (1987); Elster and Loewenstein (1992); and Rottenstreich and Christopher (2002).

³ Tversky and Kahneman (1974) originally identified three general purpose heuristics: availability, representativeness and anchoring and adjustment. See also Kahneman and Frederick (2002).

⁴ See March and Heath (1994); Weber et al. (2004); Shapira (1997); and Rottenstreich and Kivetz (2006).

⁵ For this analysis, we did not take those who chose to be indifferent between the alternatives.