Decision theory simply put, is an evaluation of the process of decision making. It strives to assess how options are made. It’s an analytical study of decision-making in a system or structure where the decision variable is unknown and the environment of a decision is not certain. It extracts tools from psychology, mathematics, statistics, and philosophy in evaluating how a decision is made. Decision theory also entails how options are analytically made depending on uncertain consequences and probabilities.

This article is an in-depth summary of decision theory, how it works and the types of decision making theories. Our assignment writing help will allow you time to relax as our professional team handles your task.

Understanding Decision Theory

It relates to the understanding of the activities causing decision-making. Decision theory is at times studied in association with the theory of games. There are various types of processes of decision-making, hence, it also comprises various areas. The three main decision theory areas include;

• Prescriptive decision-making theory: It aims to give recommendations on the best decision-making method even in questionable decision-making surroundings.
• Descriptive decision-making theory: It seeks to express how unreasonable agents make clear decisions.
• Normative decision-making theory: Depends on moral principles, this theory gives direction for decision-making.

Rational decision theory

It states that people use rational computations to make decisions and achieve results that are associated with their objectives. The outcomes are also related to maximizing the self-interest of an individual. Using rational decision theory is anticipated to cause outcomes that offer people the greatest satisfaction and benefit, given the available limited options.

Understanding rational decision theory

The majority of mainstream economic theories and assumptions are grounded in rational decision theory. The theory is related to the rational actor concepts, the invisible hand, and self-interest.

Rational decision theory is grounded on the rational actor involvement assumption. Rational agents are the people in economics who make reasonable decisions depending on the available information and calculations. Rational agents form the rational decision theory basis. Rational decision theory presumes that rational actors, or individuals, try to robustly maximize their benefits in all situations and, therefore, constantly try to reduce their losses.

An economist might use this rationality assumption as a portion of wider studies looking to understand various societal behaviors generally.

Invisible Hand and Self-Interest

Philosopher Smith was among the initial economists to unfold the underlying rational decision theory principles. Adam expounded on his self-interest studies and the theory of the invisible hand in his “A Nature Inquiry and the Nation Wealth Causes,” book which was printed in 1776.

An invisible hand is a metaphor for the invisible forces that affect a free enterprise economy. First of all, the theory of invisible hand presumes self-interest. Both further rational decision theory developments and this theory refute all negative misconceptions related to self-interest. Rather, these concepts propose that rational agents operating considering their self-interest can create economic benefits generally.

As per the theory of invisible hand, individuals motivated by rationality and self-interest will make choices that cause positive advantages for the economy at large. Through consumption and production freedom, the best society’s interests are satisfied. The constant individual pressures interplay on market demand and supply leads to the price’s natural movement and the trade flow. An economist who believes in the theory of invisible hand campaigns for less intervention of government and more exchange opportunities in the free market.

Decision making theories

These are the decision making theories to include in your assignment writing;

1.      Normative Decision-making Theory

This theory of decision analysis analyzes the ideal logical choice repercussions depending on moral principles. It also determines the optimum action course based on assumptions and limits. However, it doesn’t consider the other factors hindering it. Alternatively, it handles exceptional potential outcomes, expected behavior, and processes of decision-making. This theory utilizes computer applications, tools, and procedures to achieve an optimal choice.

2.      Optimal Decision-making Theory

This qualitative and quantitative method, often referred to as descriptive decision-making theory, analyzes irrational people’s decisions. Furthermore, it employs numerous functions, frameworks, and hypotheses, to understand practical actions following ethical values.

A company uses the decision-making theory in operation study because it examines influencing factors, several outcomes, and rational reasoning to understand the thoughts of a person logically instead of idealistically.

The optimal decision theory evaluates why and how an individual made a choice, the reasons behind the decision, and where and when that choice was made since time and location are essential in the decision-making process.

What is decision making theory

Among the underlying concepts is the ‘decision-making concept,’ which was introduced first by Economics winner of the Nobel Prize, Herbert Simon, in 1978. Simon is popular for his contribution to behaviorism also called corporate decision-making. Decision-making theory revolves around how rational people should act under uncertainty and risk. The theory proposes that decision-making refers to rational choice application and adoption of a governmental organization, private, or business management, efficiently. The theorist asserted that decision-making is selecting between alternative action courses. It might even mean selecting between non-action and action.

The decision-making theory of Herbert Simon was first revealed in his famous book, (1947) Administrative Behavior. Simon suggested that choices were crucial because if not timely taken, it’ll negatively influence the objective of an organization. The theory can be split into two sections: the actions or process taken and the choice that a person arrives at. Simply put, implementing a choice is as significant as making the choice. In this regard, ERM will assist the organization carry out its risk-based process of decision-making, which implicitly contemplates the procedure of the steps taken upon the choice at the earliest moment.

Simon’s Decision Making Theory also reflects on psychological features that a classical economist ignored or overlooked. Internal factors like motivations and stress, among others, hinder the capacity of an individual to solve complicated problems. Briefly, decisions are grounded on bounded cognition—humans behave in different ways when there exist uncertainties and risks. At the theory’s core, there exists ‘satisficing’, which refers to the combination of sufficing and satisfying. It proposes that a person should make choices that involve complications and minimum risks rather than focusing on profit maximization or pursuing objectives.

On the contrary to a classical theorist, Simon proposes that no one best exploit or decision exists. It is because one cannot have complete info about something, hence, there’ll always be an excellent decision or exploit.

How does prospect theory affect decision making?

Prospect theory is part of the subgroup of behavioral economics, describing how people decide between probabilistic choices that involve risk, and the likelihood of the various outcomes is not known. The theory was developed in the year 1979 and developed further in the year 1992 by Daniel Kahneman and Amos Tversky, making it more physically correct how decisions are made in comparison to the anticipated utility concept.

The behavior of an individual underlying explanation, under the prospect concept, is that since the decisions are singular and independent, a loss or a gain probability is reasonably estimated as being fifty/fifty rather than the presented probability. Essentially, a gain probability is generally regarded as greater.

Kahneman and Tversky proposed that a loss causes a bigger emotional effect on a person than an equivalent gain amount does, so provided choices presented 2 ways—both offering similar results—a person will select the perceived gains option.

For instance, suppose that the final result of obtaining $25. One alternative is being offered $25 wholly. The other alternative is being offered $50 and later having to refund $25. The $25 utility is exactly similar in both choices. However, people are quite likely to opt to get straight cash since a sole gain is normally seen as more beneficial than having extra cash initially and then enduring a loss.

Prospect Theory Phases

The theory maintains that you make choices through a 2-step process. Rather than considering possible choices (which will be impossible) and every available information humans utilize a two-stage process to narrow the most significant information. The steps are defined as the evaluation stage and the editing stage.

1. The Editing Stage

The editing stage is where individuals decide which data will be utilized in the evaluation phase. A Decision-maker will use conceptual shortcuts to evaluate which data is significant, and the available options. They also determine which results are most advantageous, and even classify their preferences.

The editing stage is important since it can initiate biases that appear later in the process of decision-making. If a person doesn’t consider certain improbable outcomes or makes an erroneous evaluation of the probability of that outcome, they might result in making sub-optimal choices afterward.

2. The Evaluation Stage

The evaluation phase is where individuals make their ultimate decisions, depending on the evaluations made in your editing phase. Individuals weigh each outcome’s probability and take actions depending on the identified desirability and likelihood of all outcomes.

It’s worth noting that these choices aren’t necessarily grounded in logical reasoning. Prospect theory proposes that individuals are likely to become risk-accepting with low stakes and risk-averse with high stakes. Put differently, they are likely to make decisions that reduce losses instead of maximizing expected gains.

Key Takeaways

• Decision theory includes statistical and economic approaches for learning the choices of an individual. Because it’s grounded on wishes, ideas, and attitudes.
• It allows the organization to make the most logical decision possible in uncertain and unknown behaviors, conditions, and repercussions.
• Companies globally use decision theory to understand clearly how customers market trends and make decisions to make remarkable business decisions.
• Politicians, mathematicians, philosophers, economists, psychologists, marketers, biologists, and social and data scientists, use 2 theory forms: descriptive and normative.

Conclusion

The process of making decisions is a significant cognitive psychology research area as evident in this article on decision theory. Understanding the decision-making process is essential for comprehending the choices they make. Various factors affect the decision-making process. Those factors include commitment escalation, past experiences, personal relevance beliefs, cognitive biases, and individual and age differences.

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