However, Daniel Kahneman and Amos Tversky, the developers of prospect theory, demonstrated through various experiments that most people alter that approach based on their subjective judgments in any given situation. Notice the numerical and logical approach to that analysis. Most strictly rational approaches to questions of financial risk rely on the principle of expected value, where the probability of an event is multiplied by the resulting value should the event occur. This danger, along with other limitations of the rational method, has led to the development of the following concepts to provide a more balanced and holistic approach to decision making: Prospect Theoryĭaniel Kahneman is one of the developers of prospect theory.Īn epoch-making idea in the field of behavioral economics, prospect theory is a complex analysis of how individuals make decisions when there is risk involved. Taken to its extreme, the rational method might entirely discount factors that are of known and obvious value, such as emotions and feelings, experience, or even ethical principles. Though most decision makers will recognize much that is commendable in the rational decision-making process, there are also reasons to consider complementary or even contrasting ideas. Ideas that Complement and Contrast with Rational Decision Making In a company, the final decision usually belongs to an executive, who takes the analysis as a guide but makes his own decision. If they are not fully weighted, the final analysis will lean toward whatever is easiest to measure. Some properties are not easily measured, and factors that rely on subjective judgment may not be trusted. The next stage will use these to calculate a score for each alternative. In the evaluation stage, the process usually requires numeric values. It is more useful for big decisions with many criteria that affect many people. It is generally not worthwhile on everyday decisions. The process can be time-consuming and costly. Rational decision making is defined not only by adherence to a careful process, but also by a logical, data-driven manner of following the steps of that process. It is also possible that an entirely new solution will arise during the evaluation process. The solution might be one of the particular options that was initially listed, an adaptation of one of those options, or a combination of different aspects from multiple suggestions. You should clearly state your decision so as to avoid confusion or uncertainty. Step 6: Select the Best AlternativeĪfter a careful evaluation of alternatives, you must choose a solution. Which choice is most desirable and why? Are all of the options equally feasible, or are some unrealistic or impossible? Now is the time to identify both the merits and the challenges involved in each of the possible solutions. Step 5: Evaluate AlternativesĪfter creating a somewhat full list of possible alternatives, each alternative can be evaluated. The alternatives you generated could include the types of cars, as well as using public transportation, car pooling and a ride-hailing service. Some of those alternatives will be common and fairly obvious options, but it is often helpful to be creative and name unusual solutions as well. Once you have identified the issue and gathered relevant information, now it is time to list potential options for how to decide what to do. For example, you may have weighted budget, safety, and reliability as the most important criteria to consider, along with several other slightly less critical criteria. Step 3: Weigh Decision Criteriaīecause the criteria identified will seldom be equally important, you will need to weight the criteria to create the correct priority in the decision. Some of the criteria identified might include budget, safety, functionality, and reliability. To continue our example, let’s assume you are married. This step will bring the decision maker’s, and any other stakeholder’s, interests, values and preferences into the process. In this step, the decision maker needs to determine what is relevant in making the decision. However, the central problem is that you need a reliable way to commute to and from work. For example, you have taken a new job and you may initially decide you need to find a new car for commuting back and forth from work. It can sometimes require serious thought to find the central issue that must be addressed. Though this starting place might seem rather obvious, a failure to identify the problem clearly can derail the entire process.
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