Paradoxes and Violations of Normative Decision Theory

Traditional economic decision theory proposes that people behave in certain ways when faced with a well-formulated set of alternatives and information. It is a normative theory; it suggests that people should act according to certain decision rules, but not that they will necessarily do so in reality. The standard assumption is that a person has a utility function over all possible outcomes, which defines the desirability or usefulness of any given scenario. Traditional utility theory asserts that in a decision without uncertainty, a person should choose the alternative resulting in the highest level of utility, and that in a decision with uncertainty, a person should choose the alternative with the highest expected utility. Detailed explanations are given by von Neumann and Morgenstern and Savage [1,2]. These ideas are generally sound and can be valuable when used as a guide for decision makers. However, it was initially thought that they were also valuable as a descriptive theory. It has since been determined that people violate normative decision theory in many clear and predictable ways. In this article, we introduce and discuss several of these interesting behavioral phenomena. One of the earliest researchers to demonstrate a deviation from expected utility theory was Allais [3]. He distributed two surveys. In the first survey, respondents were asked to choose between the following