Conceptual skills refer to the managers ability to think in the abstract. This exercise will aid you
Question:
Conceptual skills refer to the manager’s ability to think in the abstract. This exercise will aid you in understanding the effects that non-rational biases and risk propensity can have on decision making.
Exercise Background
Two psychologists, Amos Tversky and Daniel Kahneman, conducted much of the research that led to our knowledge of decision-making biases. Tversky and Kahneman found that they could understand individuals’ real-life choices by presenting experimental subjects with simulated decisions in a laboratory setting. They developed a theory called prospect theory, which uses behavioral psychology to explain why individuals are non-rational when making economic decisions. Their work has contributed a great deal to the developing discipline of behavioral economics. In fact, Kahneman won the 2002 Nobel Prize in Economics for development of these concepts. (Tversky could not share in the award because the Nobel Prize cannot be given posthumously.)
Tversky and Kahneman’s most important finding was that an individual’s perception of gain or loss in a situation is more important than an objective measure of gain or loss. Thus individuals are nonrational—that is, they do not make decisions based purely on rational criteria.
Related to this conclusion, Tversky and Kahneman found that humans think differently about gains and losses. This is called framing. Another finding is that people allow their perceptions to be skewed positively or negatively, depending on information they receive. Later, when new information becomes available, people have a hard time letting go of their initial perceptions, even if the new information contradicts their original impressions. This effect is referred to as anchoring and adjustment.
To answer the following questions, you must be able to calculate an expected value. To calculate an expected value, multiply each possible outcome value by the probability of its occurrence, and then sum all the results. Here is a simple example: You have a 50 percent chance of earning 80 points on an exam and a 50 percent chance of earning 70 points. The expected value can be calculated as (.5 + 80) + (.5 × 70), or a .5 chance of 80 points (equal to 40 points) plus a .5 chance of 70 points (equal to 35 points). Therefore, the expected value of your exam is 75 points.
What have you learned about decision-making biases and risk propensity from these experiments?
Horngrens Financial and Managerial Accounting
ISBN: 978-0133866292
5th edition
Authors: Tracie L. Nobles, Brenda L. Mattison, Ella Mae Matsumura