Prospect Theory

The prospect theory explains how people make decision that has risks. It uses the equation V=v(x)*p(x), where V is the value of the prospect, v(x) is the value function, and p(x) is the probability function. For example, to find the prospect of a lottery that has 40% to win $100 and 60% to lose $50, we can use the equation, V=v(100)*p(40) + v(-50)*p(60). The prospect theory suggests that if there are choices with losses, people tend to avoid them. For instance, if they were to choose either to get $25 or get $100 and return $75, they would choose the first option. This is because the fear of loss is about two times greater than the satisfaction from gain.