Prospect Theory

Definition

Prospect theory is a psychological account that describes how people make decisions under conditions of uncertainty. These may involve decisions about nearly anything where the outcome of the decision is somewhat risky or uncertain, from deciding whether to buy a lottery ticket, to marry one's current romantic partner, to undergo chemotherapy treatment, or to invest in life insurance.

Prospect theory predicts that people go through two distinct stages when deciding between risky options like these. In the first phase, decision makers are predicted to edit a complicated decision into a simpler decision, usually specified as gains versus losses. Purchasing a car is simplified into losing $20,000 and gaining a car, whereas buying a lottery ticket is simplified into losing $1 and gaining a small chance to ...