Question

Give three examples on how prospect theory challenges rational behavioral assumptions of the utility theory.

Answer 1

IF lets assume Rational behavioral utility theory is at work then rational consumer would choose the best possible outcome that maximises his/her utilty but it is not the case, generally if we give a choice of lottery and guarenteed payment to rational consumer he would generally choose guarenteed payment over a lottery it is due to certeintiy effect.

Examples are as follows

1) Lottary

2) Traders in Investment Banks genrally trade in risky contracts to recouop the losses they hae incurred previously.

3) Not willingness of buying life insurance cover of Family head person as he sees lost opportunity cost in terms of premium paid