Prospect Theory: Critique On Default Setting

Default setting is closely related to one of the main themes in behavioural economics, prospect theory. The model on prospect theory has been developed in response to critique on expected utility theory as a model of decision making under risk (Kahneman & Tversky, 1979). Prospect theory is a behavioural model showing how individuals decide between alternatives that involve risk and uncertainty. It distinguishes itself from expected utility theory by comparing the expected utility to reference points rather than to absolute outcomes (e.g. reference dependence). Prospect theory asserts that individuals are loss-averse and, therefore, more willing to take risks in order to avoid a loss than when they face a possible equivalent gain (Kahneman, 2011). In other words, individuals dislike losses more than they like corresponding gains, because losses are valued more than gains.

The status quo bias entails that people hold on to decisions made previously (inertia), and has been proved in a laboratory-based experiment performed by Samuelson and Zeckhauser (1988). It is argued if the accuracy of the findings and predictions found in laboratory experiments still holds outside laboratory. This might entail that using the status quo bias as an extra parameter may not result in consistent outcomes across different applications. However, the experiment on the status quo bias is conducted in 1988 and behavioural economics has made major developments ever since. The various real life applications of default setting, and thereby in many cases also the status quo bias, shows their existence. It also shows that default setting is broadly applicable and has many economic implications, opposed to the criticisms of Pesendorfer (2006) on behavioural economics to become economic psychology because of the focus on the mental processes guiding